Is Indiabulls Real Estate (NSE:IBREALEST) Using Too Much Debt?

Warren Buffett famously said, '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. We note that Indiabulls Real Estate Limited (NSE:IBREALEST) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Indiabulls Real Estate

What Is Indiabulls Real Estate's Debt?

The image below, which you can click on for greater detail, shows that Indiabulls Real Estate had debt of ₹16.7b at the end of March 2021, a reduction from ₹33.3b over a year. On the flip side, it has ₹11.3b in cash leading to net debt of about ₹5.38b.

A Look At Indiabulls Real Estate's Liabilities

Zooming in on the latest balance sheet data, we can see that Indiabulls Real Estate had liabilities of ₹47.0b due within 12 months and liabilities of ₹5.60b due beyond that. On the other hand, it had cash of ₹11.3b and ₹5.35b worth of receivables due within a year. So it has liabilities totalling ₹36.0b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₹44.5b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Indiabulls Real Estate's debt to EBITDA ratio (3.0) suggests that it uses some debt, its interest cover is very weak, at 0.71, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Indiabulls Real Estate's EBIT was down 81% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Indiabulls Real Estate will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Indiabulls Real Estate saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Indiabulls Real Estate's conversion of EBIT to free cash flow 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 level of total liabilities fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Indiabulls Real Estate has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Indiabulls Real Estate you should be aware of, and 2 of them are a bit unpleasant.

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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