Nahar Poly Films (NSE:NAHARPOLY) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Nahar Poly Films Limited (NSE:NAHARPOLY) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Nahar Poly Films

What Is Nahar Poly Films's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Nahar Poly Films had debt of ₹555.4m, up from ₹35.9m in one year. However, it also had ₹234.3m in cash, and so its net debt is ₹321.1m.

How Healthy Is Nahar Poly Films' Balance Sheet?

We can see from the most recent balance sheet that Nahar Poly Films had liabilities of ₹850.4m falling due within a year, and liabilities of ₹428.0m due beyond that. Offsetting these obligations, it had cash of ₹234.3m as well as receivables valued at ₹113.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹930.7m.

While this might seem like a lot, it is not so bad since Nahar Poly Films has a market capitalization of ₹4.20b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Nahar Poly Films's net debt is only 0.49 times its EBITDA. And its EBIT easily covers its interest expense, being 188 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Nahar Poly Films grew its EBIT by 59% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Nahar Poly Films 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Nahar Poly Films saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Happily, Nahar Poly Films's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Nahar Poly Films 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. 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. For example, we've discovered 4 warning signs for Nahar Poly Films (1 is significant!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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