Cinevista (NSE:CINEVISTA) Seems To Be Using A Lot Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Cinevista Limited (NSE:CINEVISTA) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Cinevista

How Much Debt Does Cinevista Carry?

As you can see below, at the end of September 2022, Cinevista had ₹652.3m of debt, up from ₹584.6m 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 Healthy Is Cinevista's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cinevista had liabilities of ₹58.3m due within 12 months and liabilities of ₹652.3m due beyond that. Offsetting these obligations, it had cash of ₹87.0k as well as receivables valued at ₹61.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹649.3m.

This deficit is considerable relative to its market capitalization of ₹729.4m, so it does suggest shareholders should keep an eye on Cinevista's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Cinevista shareholders face the double whammy of a high net debt to EBITDA ratio (13.9), and fairly weak interest coverage, since EBIT is just 0.84 times the interest expense. The debt burden here is substantial. However, the silver lining was that Cinevista achieved a positive EBIT of ₹47m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Cinevista will need earnings to service that debt. 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Cinevista saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Cinevista's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. We're quite clear that we consider Cinevista to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Be aware that Cinevista is showing 4 warning signs in our investment analysis , you should know about...

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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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.