Here's Why Phoenix Mills (NSE:PHOENIXLTD) Can Manage Its Debt Responsibly

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. Importantly, The Phoenix Mills Limited (NSE:PHOENIXLTD) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 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 Phoenix Mills

What Is Phoenix Mills's Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Phoenix Mills had debt of ₹42.6b, up from ₹39.8b in one year. On the flip side, it has ₹6.30b in cash leading to net debt of about ₹36.3b.

How Healthy Is Phoenix Mills' Balance Sheet?

The latest balance sheet data shows that Phoenix Mills had liabilities of ₹25.8b due within a year, and liabilities of ₹39.3b falling due after that. On the other hand, it had cash of ₹6.30b and ₹2.88b worth of receivables due within a year. So it has liabilities totalling ₹56.0b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Phoenix Mills has a market capitalization of ₹270.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Phoenix Mills has net debt worth 2.4 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.8 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Notably, Phoenix Mills's EBIT launched higher than Elon Musk, gaining a whopping 134% on last year. 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 Phoenix Mills can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Phoenix Mills actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Phoenix Mills's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its interest cover does undermine this impression a bit. Taking all this data into account, it seems to us that Phoenix Mills takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Phoenix Mills is showing 1 warning sign in our investment analysis , you should know about...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.