We Think Tamil Nadu Newsprint and Papers (NSE:TNPL) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Tamil Nadu Newsprint and Papers Limited (NSE:TNPL) makes use of debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tamil Nadu Newsprint and Papers

What Is Tamil Nadu Newsprint and Papers's Debt?

The image below, which you can click on for greater detail, shows that Tamil Nadu Newsprint and Papers had debt of ₹22.2b at the end of March 2022, a reduction from ₹27.1b over a year. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Tamil Nadu Newsprint and Papers' Balance Sheet?

According to the last reported balance sheet, Tamil Nadu Newsprint and Papers had liabilities of ₹21.9b due within 12 months, and liabilities of ₹19.9b due beyond 12 months. Offsetting these obligations, it had cash of ₹135.0m as well as receivables valued at ₹2.75b due within 12 months. So its liabilities total ₹39.0b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹12.7b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Tamil Nadu Newsprint and Papers would likely require a major re-capitalisation if it had to pay its creditors today.

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).

Weak interest cover of 0.83 times and a disturbingly high net debt to EBITDA ratio of 6.2 hit our confidence in Tamil Nadu Newsprint and Papers like a one-two punch to the gut. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Tamil Nadu Newsprint and Papers actually grew its EBIT by a hefty 142%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Tamil Nadu Newsprint and Papers'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Tamil Nadu Newsprint and Papers generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

To be frank both Tamil Nadu Newsprint and Papers's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Tamil Nadu Newsprint and Papers's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. Be aware that Tamil Nadu Newsprint and Papers is showing 3 warning signs in our investment analysis , and 2 of those shouldn't be ignored...

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. 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.