Is Emami Realty (NSE:EMAMIREAL) A Risky Investment?

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.' 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 Emami Realty Limited (NSE:EMAMIREAL) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Emami Realty

What Is Emami Realty's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Emami Realty had ₹17.2b of debt in September 2021, down from ₹29.1b, one year before. On the flip side, it has ₹1.28b in cash leading to net debt of about ₹15.9b.

How Strong Is Emami Realty's Balance Sheet?

The latest balance sheet data shows that Emami Realty had liabilities of ₹15.9b due within a year, and liabilities of ₹2.58b falling due after that. Offsetting this, it had ₹1.28b in cash and ₹8.71b in receivables that were due within 12 months. So its liabilities total ₹8.49b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹3.00b company, like a colossus towering over mere mortals. 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.

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.

Weak interest cover of 2.2 times and a disturbingly high net debt to EBITDA ratio of 11.1 hit our confidence in Emami Realty like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that Emami Realty achieved a positive EBIT of ₹1.4b in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is Emami Realty's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last year, Emami Realty produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

To be frank both Emami Realty's net debt to EBITDA 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. Overall, we think it's fair to say that Emami Realty has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. We've identified 3 warning signs with Emami Realty (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.