Is Orient Paper & Industries (NSE:ORIENTPPR) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Orient Paper & Industries Limited (NSE:ORIENTPPR) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out our latest analysis for Orient Paper & Industries

What Is Orient Paper & Industries's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2020 Orient Paper & Industries had debt of ₹287.4m, up from ₹212.9m in one year. However, because it has a cash reserve of ₹33.0m, its net debt is less, at about ₹254.4m.

A Look At Orient Paper & Industries's Liabilities

The latest balance sheet data shows that Orient Paper & Industries had liabilities of ₹1.82b due within a year, and liabilities of ₹2.50b falling due after that. On the other hand, it had cash of ₹33.0m and ₹390.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.9b.

This is a mountain of leverage relative to its market capitalization of ₹3.94b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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

Orient Paper & Industries's net debt is only 0.52 times its EBITDA. And its EBIT covers its interest expense a whopping 28.7 times over. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Orient Paper & Industries if management cannot prevent a repeat of the 84% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Orient Paper & 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Orient Paper & Industries generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

We feel some trepidation about Orient Paper & Industries's difficulty EBIT growth rate, but we've got positives to focus on, too. To wit both its interest cover and conversion of EBIT to free cash flow were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Orient Paper & Industries is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Case in point: We've spotted 3 warning signs for Orient Paper & Industries you should be aware of.

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. 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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