Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Tata Global Beverages Limited (NSE:TATAGLOBAL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Tata Global Beverages
What Is Tata Global Beverages's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Tata Global Beverages had ₹11.5b of debt, an increase on ₹10.7b, over one year. But it also has ₹15.7b in cash to offset that, meaning it has ₹4.23b net cash.
A Look At Tata Global Beverages's Liabilities
According to the last reported balance sheet, Tata Global Beverages had liabilities of ₹14.7b due within 12 months, and liabilities of ₹11.1b due beyond 12 months. Offsetting these obligations, it had cash of ₹15.7b as well as receivables valued at ₹9.85b due within 12 months. So these liquid assets roughly match the total liabilities.
Having regard to Tata Global Beverages's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹171.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Tata Global Beverages boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Tata Global Beverages saw its EBIT decline by 5.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Tata Global Beverages can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Tata Global Beverages has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Tata Global Beverages created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Tata Global Beverages has ₹4.23b in net cash. So we are not troubled with Tata Global Beverages's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Tata Global Beverages's earnings per share history for free.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.