Is Shree Rama Newsprint (NSE:RAMANEWS) Using Debt Sensibly?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Shree Rama Newsprint Limited (NSE:RAMANEWS) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shree Rama Newsprint

What Is Shree Rama Newsprint's Debt?

As you can see below, at the end of September 2020, Shree Rama Newsprint had ₹3.89b of debt, up from ₹3.30b a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Shree Rama Newsprint's Balance Sheet?

According to the last reported balance sheet, Shree Rama Newsprint had liabilities of ₹4.05b due within 12 months, and liabilities of ₹1.07b due beyond 12 months. Offsetting these obligations, it had cash of ₹1.55m as well as receivables valued at ₹186.4m due within 12 months. So it has liabilities totalling ₹4.94b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₹2.17b 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'd watch its balance sheet closely, without a doubt. After all, Shree Rama Newsprint would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shree Rama Newsprint 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.

In the last year Shree Rama Newsprint had a loss before interest and tax, and actually shrunk its revenue by 36%, to ₹2.2b. To be frank that doesn't bode well.

Caveat Emptor

While Shree Rama Newsprint's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable ₹553m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through ₹282m in negative free cash flow over the last year. That means it's on the risky side of things. 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. We've identified 3 warning signs with Shree Rama Newsprint (at least 2 which can't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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