These 4 Measures Indicate That TARC (NSE:TARC) Is Using Debt Extensively

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that TARC Limited (NSE:TARC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for TARC

How Much Debt Does TARC Carry?

The chart below, which you can click on for greater detail, shows that TARC had ₹13.3b in debt in September 2023; about the same as the year before. However, it also had ₹380.3m in cash, and so its net debt is ₹12.9b.

How Strong Is TARC's Balance Sheet?

The latest balance sheet data shows that TARC had liabilities of ₹9.43b due within a year, and liabilities of ₹9.44b falling due after that. Offsetting this, it had ₹380.3m in cash and ₹708.2m in receivables that were due within 12 months. So its liabilities total ₹17.8b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since TARC has a market capitalization of ₹43.2b, 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.

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).

TARC shareholders face the double whammy of a high net debt to EBITDA ratio (11.0), and fairly weak interest coverage, since EBIT is just 0.95 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for TARC is that it turned last year's EBIT loss into a gain of ₹1.1b, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is TARC'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, TARC's free cash flow amounted to 20% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, TARC's net debt to EBITDA left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. Looking at the bigger picture, it seems clear to us that TARC's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with TARC .

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.