Is Emami Paper Mills (NSE:EMAMIPAP) Using Too Much Debt?

Warren Buffett famously said, '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 Emami Paper Mills Limited (NSE:EMAMIPAP) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Emami Paper Mills

How Much Debt Does Emami Paper Mills Carry?

You can click the graphic below for the historical numbers, but it shows that Emami Paper Mills had ₹14.0b of debt in March 2020, down from ₹15.5b, one year before. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Emami Paper Mills's Balance Sheet?

According to the last reported balance sheet, Emami Paper Mills had liabilities of ₹8.44b due within 12 months, and liabilities of ₹8.55b due beyond 12 months. Offsetting this, it had ₹234.9m in cash and ₹2.23b in receivables that were due within 12 months. So its liabilities total ₹14.5b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹4.53b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Emami Paper Mills would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.5 times and a disturbingly high net debt to EBITDA ratio of 5.6 hit our confidence in Emami Paper Mills like a one-two punch to the gut. The debt burden here is substantial. Another concern for investors might be that Emami Paper Mills's EBIT fell 11% in the last year. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Emami Paper Mills 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Emami Paper Mills produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, Emami Paper Mills's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that Emami Paper Mills's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for Emami Paper Mills (of which 1 makes us a bit uncomfortable!) you should know about.

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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This article by Simply Wall St is general in nature. 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.
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