Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Marathon Nextgen Realty Limited (NSE:MARATHON) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Marathon Nextgen Realty's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 Marathon Nextgen Realty had ₹7.51b of debt, an increase on ₹5.68b, over one year. On the flip side, it has ₹1.28b in cash leading to net debt of about ₹6.23b.
A Look At Marathon Nextgen Realty's Liabilities
The latest balance sheet data shows that Marathon Nextgen Realty had liabilities of ₹3.82b due within a year, and liabilities of ₹7.03b falling due after that. Offsetting these obligations, it had cash of ₹1.28b as well as receivables valued at ₹2.89b due within 12 months. So it has liabilities totalling ₹6.68b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the ₹3.36b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Marathon Nextgen Realty would likely require a major re-capitalisation if it had to pay its creditors today.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Marathon Nextgen Realty shareholders face the double whammy of a high net debt to EBITDA ratio (9.8), and fairly weak interest coverage, since EBIT is just 1.3 times the interest expense. The debt burden here is substantial. Given the debt load, it's hardly ideal that Marathon Nextgen Realty's EBIT was pretty flat over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Marathon Nextgen 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Marathon Nextgen Realty created free cash flow amounting to 2.4% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
On the face of it, Marathon Nextgen Realty's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. After considering the datapoints discussed, we think Marathon Nextgen Realty has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Marathon Nextgen Realty you should be aware of, and 2 of them are significant.
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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