Is TCPL Packaging (NSE:TCPLPACK) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that TCPL Packaging Limited (NSE:TCPLPACK) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for TCPL Packaging

What Is TCPL Packaging's Net Debt?

The chart below, which you can click on for greater detail, shows that TCPL Packaging had ₹3.54b in debt in September 2020; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.

How Strong Is TCPL Packaging's Balance Sheet?

According to the last reported balance sheet, TCPL Packaging had liabilities of ₹3.46b due within 12 months, and liabilities of ₹2.02b due beyond 12 months. Offsetting these obligations, it had cash of ₹43.3m as well as receivables valued at ₹1.71b due within 12 months. So it has liabilities totalling ₹3.73b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₹3.53b, we think shareholders really should watch TCPL Packaging's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about TCPL Packaging's net debt to EBITDA ratio of 2.9, we think its super-low interest cover of 2.2 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Fortunately, TCPL Packaging grew its EBIT by 6.2% in the last year, slowly shrinking its debt relative to earnings. There's no doubt that we learn most about debt from the balance sheet. But it is TCPL Packaging'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, TCPL Packaging created free cash flow amounting to 20% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

To be frank both TCPL Packaging's level of total liabilities and its track record of covering its interest expense with its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, we think it's fair to say that TCPL Packaging has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with TCPL Packaging (including 2 which are a bit unpleasant) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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