These 4 Measures Indicate That Century Textiles and Industries (NSE:CENTURYTEX) Is Using Debt Reasonably Well

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 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Century Textiles and Industries

How Much Debt Does Century Textiles and Industries Carry?

As you can see below, Century Textiles and Industries had ₹13.5b of debt at September 2022, down from ₹14.7b a year prior. However, because it has a cash reserve of ₹2.35b, its net debt is less, at about ₹11.1b.

A Look At Century Textiles and Industries' Liabilities

According to the last reported balance sheet, Century Textiles and Industries had liabilities of ₹35.3b due within 12 months, and liabilities of ₹7.97b due beyond 12 months. Offsetting these obligations, it had cash of ₹2.35b as well as receivables valued at ₹2.09b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹38.8b.

While this might seem like a lot, it is not so bad since Century Textiles and Industries has a market capitalization of ₹85.8b, 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Century Textiles and Industries's moderate net debt to EBITDA ratio ( being 2.1), indicates prudence when it comes to debt. And its strong interest cover of 13.6 times, makes us even more comfortable. Notably, Century Textiles and Industries's EBIT launched higher than Elon Musk, gaining a whopping 121% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Century Textiles and Industries 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Century Textiles and Industries recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Century Textiles and Industries's interest cover was a real positive on this analysis, as was its EBIT growth rate. On the other hand, its conversion of EBIT to free cash flow makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Century Textiles and Industries is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Case in point: We've spotted 2 warning signs for Century Textiles and Industries you should be aware of, and 1 of them is potentially serious.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.