Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Coromandel International Limited (NSE:COROMANDEL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Coromandel International's Debt?
As you can see below, at the end of September 2022, Coromandel International had ₹12.8b of debt, up from ₹1.54b a year ago. Click the image for more detail. However, it does have ₹6.07b in cash offsetting this, leading to net debt of about ₹6.72b.
A Look At Coromandel International's Liabilities
Zooming in on the latest balance sheet data, we can see that Coromandel International had liabilities of ₹90.3b due within 12 months and liabilities of ₹4.50b due beyond that. Offsetting these obligations, it had cash of ₹6.07b as well as receivables valued at ₹68.7b due within 12 months. So its liabilities total ₹20.0b more than the combination of its cash and short-term receivables.
Of course, Coromandel International has a market capitalization of ₹284.1b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Coromandel International has a low net debt to EBITDA ratio of only 0.25. And its EBIT easily covers its interest expense, being 244 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Coromandel International grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Coromandel International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Coromandel International recorded free cash flow worth 57% 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.
The good news is that Coromandel International's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think Coromandel International is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Coromandel International (1 is concerning!) that you should be aware of before investing here.
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.
Valuation is complex, but we're helping make it simple.
Find out whether Coromandel International is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.