Is Shemaroo Entertainment (NSE:SHEMAROO) A Risky Investment?

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 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. Importantly, Shemaroo Entertainment Limited (NSE:SHEMAROO) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Shemaroo Entertainment

How Much Debt Does Shemaroo Entertainment Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Shemaroo Entertainment had ₹2.71b of debt, an increase on ₹2.52b, over one year. However, because it has a cash reserve of ₹73.4m, its net debt is less, at about ₹2.64b.

A Look At Shemaroo Entertainment's Liabilities

The latest balance sheet data shows that Shemaroo Entertainment had liabilities of ₹2.84b due within a year, and liabilities of ₹204.5m falling due after that. On the other hand, it had cash of ₹73.4m and ₹968.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.01b.

While this might seem like a lot, it is not so bad since Shemaroo Entertainment has a market capitalization of ₹3.40b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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). 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).

Shemaroo Entertainment shareholders face the double whammy of a high net debt to EBITDA ratio (10.2), and fairly weak interest coverage, since EBIT is just 0.64 times the interest expense. The debt burden here is substantial. Worse, Shemaroo Entertainment's EBIT was down 43% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shemaroo Entertainment's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Shemaroo Entertainment barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

On the face of it, Shemaroo Entertainment's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow fails to inspire much confidence. After considering the datapoints discussed, we think Shemaroo Entertainment has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Shemaroo Entertainment (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.
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