Here's Why Emami Realty (NSE:EMAMIREAL) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Emami Realty Limited (NSE:EMAMIREAL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Emami Realty

What Is Emami Realty's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Emami Realty had debt of ₹29.1b, up from ₹27.5b in one year. However, because it has a cash reserve of ₹2.15b, its net debt is less, at about ₹26.9b.

How Strong Is Emami Realty's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Emami Realty had liabilities of ₹28.0b due within 12 months and liabilities of ₹2.55b due beyond that. Offsetting these obligations, it had cash of ₹2.15b as well as receivables valued at ₹13.4b due within 12 months. So its liabilities total ₹15.0b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹1.32b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Emami Realty would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Emami Realty shareholders face the double whammy of a high net debt to EBITDA ratio (24.0), and fairly weak interest coverage, since EBIT is just 0.87 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Emami Realty actually grew its EBIT by a hefty 398%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Emami Realty will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Emami Realty generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

To be frank both Emami Realty's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Emami Realty's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less 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 learn about the 3 warning signs we've spotted with Emami Realty (including 1 which doesn't sit too well with us) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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. 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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