These 4 Measures Indicate That Barak Valley Cements (NSE:BVCL) Is Using Debt Extensively

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Barak Valley Cements Limited (NSE:BVCL) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Barak Valley Cements

What Is Barak Valley Cements's Net Debt?

The chart below, which you can click on for greater detail, shows that Barak Valley Cements had ₹998.1m in debt in March 2020; about the same as the year before. However, because it has a cash reserve of ₹31.8m, its net debt is less, at about ₹966.2m.

How Strong Is Barak Valley Cements's Balance Sheet?

The latest balance sheet data shows that Barak Valley Cements had liabilities of ₹869.8m due within a year, and liabilities of ₹757.4m falling due after that. On the other hand, it had cash of ₹31.8m and ₹135.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.5b.

This deficit casts a shadow over the ₹304.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Barak Valley Cements would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Weak interest cover of 1.1 times and a disturbingly high net debt to EBITDA ratio of 5.2 hit our confidence in Barak Valley Cements like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The good news is that Barak Valley Cements grew its EBIT a smooth 54% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. 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 Barak Valley Cements will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Barak Valley Cements recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Barak Valley Cements's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Barak Valley Cements has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Barak Valley Cements you should be aware of, and 2 of them are potentially serious.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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