Is Rajshree Polypack (NSE:RPPL) Using Too Much Debt?

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.' 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. As with many other companies Rajshree Polypack Limited (NSE:RPPL) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Rajshree Polypack

What Is Rajshree Polypack's Debt?

As you can see below, Rajshree Polypack had ₹865.7m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had ₹38.1m in cash, and so its net debt is ₹827.6m.

How Healthy Is Rajshree Polypack's Balance Sheet?

The latest balance sheet data shows that Rajshree Polypack had liabilities of ₹959.1m due within a year, and liabilities of ₹313.2m falling due after that. Offsetting this, it had ₹38.1m in cash and ₹421.5m in receivables that were due within 12 months. So its liabilities total ₹812.7m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Rajshree Polypack has a market capitalization of ₹2.92b, 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 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.

While Rajshree Polypack has a quite reasonable net debt to EBITDA multiple of 2.3, its interest cover seems weak, at 2.4. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. One way Rajshree Polypack could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 19%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But it is Rajshree Polypack's earnings that will influence how the balance sheet holds up in the future. 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Rajshree Polypack burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Rajshree Polypack's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its EBIT growth rate was refreshing. When we consider all the factors discussed, it seems to us that Rajshree Polypack is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Be aware that Rajshree Polypack is showing 4 warning signs in our investment analysis , and 2 of those can't be ignored...

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. 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.