We Think Aditya Birla Real Estate (NSE:ABREL) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Aditya Birla Real Estate Limited (NSE:ABREL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Aditya Birla Real Estate

How Much Debt Does Aditya Birla Real Estate Carry?

As you can see below, at the end of September 2024, Aditya Birla Real Estate had ₹47.5b of debt, up from ₹22.6b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹8.08b, its net debt is less, at about ₹39.5b.

A Look At Aditya Birla Real Estate's Liabilities

We can see from the most recent balance sheet that Aditya Birla Real Estate had liabilities of ₹59.3b falling due within a year, and liabilities of ₹39.0b due beyond that. Offsetting these obligations, it had cash of ₹8.08b as well as receivables valued at ₹1.52b due within 12 months. So its liabilities total ₹88.7b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Aditya Birla Real Estate is worth ₹223.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Aditya Birla Real Estate has a sky high EBITDA ratio of 7.6, implying high debt, but a strong interest coverage of 37.7. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably, Aditya Birla Real Estate's EBIT launched higher than Elon Musk, gaining a whopping 118% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Aditya Birla Real Estate's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Aditya Birla Real Estate burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We feel some trepidation about Aditya Birla Real Estate's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. To wit both its interest cover and EBIT growth rate were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Aditya Birla Real Estate is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Aditya Birla Real Estate (including 1 which is a bit unpleasant) .

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.