Century Textiles and Industries (NSE:CENTURYTEX) Has A Pretty Healthy Balance Sheet

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.' 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 Century Textiles and Industries Limited (NSE:CENTURYTEX) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Century Textiles and Industries

What Is Century Textiles and Industries's Debt?

As you can see below, Century Textiles and Industries had ₹10.6b of debt at March 2023, down from ₹13.4b a year prior. On the flip side, it has ₹1.03b in cash leading to net debt of about ₹9.56b.

How Strong Is Century Textiles and Industries' Balance Sheet?

According to the last reported balance sheet, Century Textiles and Industries had liabilities of ₹33.8b due within 12 months, and liabilities of ₹10.3b due beyond 12 months. On the other hand, it had cash of ₹1.03b and ₹3.07b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹40.0b.

While this might seem like a lot, it is not so bad since Century Textiles and Industries has a market capitalization of ₹120.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Century Textiles and Industries's net debt of 1.9 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.2 times interest expense) certainly does not do anything to dispel this impression. If Century Textiles and Industries can keep growing EBIT at last year's rate of 17% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Century Textiles and Industries 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Century Textiles and Industries recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Century Textiles and Industries's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And we also thought its interest cover was a positive. Looking at all the aforementioned factors together, it strikes us that Century Textiles and Industries can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Century Textiles and Industries , and understanding them should be part of your investment process.

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.