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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.’ 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. As with many other companies. Music Broadcast Limited (NSE:RADIOCITY) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company’s debt levels is to consider its cash and debt together.
What Is Music Broadcast’s Net Debt?
The image below, which you can click on for greater detail, shows that Music Broadcast had debt of ₹156.3m at the end of March 2019, a reduction from ₹499.1m over a year. But on the other hand it also has ₹2.49b in cash, leading to a ₹2.33b net cash position.
How Healthy Is Music Broadcast’s Balance Sheet?
According to the last reported balance sheet, Music Broadcast had liabilities of ₹1.07b due within 12 months, and liabilities of ₹198.4m due beyond 12 months. Offsetting these obligations, it had cash of ₹2.49b as well as receivables valued at ₹1.25b due within 12 months. So it can boast ₹2.47b more liquid assets than total liabilities.
This surplus suggests that Music Broadcast is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Music Broadcast boasts net cash, so it’s fair to say it does not have a heavy debt load!
Another good sign is that Music Broadcast has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Music Broadcast can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Music Broadcast has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Music Broadcast produced sturdy free cash flow equating to 52% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company’s debt, in this case Music Broadcast has ₹2.3b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 22% over the last year. So is Music Broadcast’s debt a risk? It doesn’t seem so to us. We’d be very excited to see if Music Broadcast insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.