We Think West Coast Paper Mills (NSE:WSTCSTPAPR) Can Manage Its Debt With Ease

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that West Coast Paper Mills Limited (NSE:WSTCSTPAPR) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for West Coast Paper Mills

What Is West Coast Paper Mills's Net Debt?

The image below, which you can click on for greater detail, shows that West Coast Paper Mills had debt of ₹4.78b at the end of March 2022, a reduction from ₹5.14b over a year. On the flip side, it has ₹3.87b in cash leading to net debt of about ₹916.7m.

How Healthy Is West Coast Paper Mills' Balance Sheet?

The latest balance sheet data shows that West Coast Paper Mills had liabilities of ₹7.89b due within a year, and liabilities of ₹5.19b falling due after that. Offsetting this, it had ₹3.87b in cash and ₹3.53b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹5.68b.

Given West Coast Paper Mills has a market capitalization of ₹41.3b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). 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).

West Coast Paper Mills's net debt is only 0.11 times its EBITDA. And its EBIT easily covers its interest expense, being 36.0 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, West Coast Paper Mills grew its EBIT by 464% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is West Coast Paper Mills's earnings that will influence how the balance sheet holds up in the future. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, West Coast Paper Mills actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, West Coast Paper Mills's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. We think West Coast Paper Mills is no more beholden to its lenders, than the birds are to birdwatchers. To our minds it has a healthy happy balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for West Coast Paper Mills you should be aware of, and 1 of them can't be ignored.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.