Is Som Distilleries & Breweries (NSE:SDBL) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Som Distilleries & Breweries Limited (NSE:SDBL) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Som Distilleries & Breweries

What Is Som Distilleries & Breweries's Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Som Distilleries & Breweries had debt of ₹1.97b, up from ₹1.78b in one year. However, because it has a cash reserve of ₹94.9m, its net debt is less, at about ₹1.88b.

How Strong Is Som Distilleries & Breweries' Balance Sheet?

We can see from the most recent balance sheet that Som Distilleries & Breweries had liabilities of ₹2.93b falling due within a year, and liabilities of ₹1.17b due beyond that. Offsetting this, it had ₹94.9m in cash and ₹1.17b in receivables that were due within 12 months. So it has liabilities totalling ₹2.83b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Som Distilleries & Breweries has a market capitalization of ₹7.72b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Som Distilleries & Breweries has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 2.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. One redeeming factor for Som Distilleries & Breweries is that it turned last year's EBIT loss into a gain of ₹431m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Som Distilleries & Breweries will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, Som Distilleries & Breweries created free cash flow amounting to 8.1% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Som Distilleries & Breweries's conversion of EBIT to free cash flow left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Som Distilleries & Breweries stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Som Distilleries & Breweries is showing 4 warning signs in our investment analysis , and 2 of those are concerning...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.