Nila Spaces (NSE:NILASPACES) Takes On Some Risk With Its Use Of Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Nila Spaces Limited (NSE:NILASPACES) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Nila Spaces

What Is Nila Spaces's Debt?

The image below, which you can click on for greater detail, shows that Nila Spaces had debt of ₹264.6m at the end of September 2020, a reduction from ₹823.2m over a year. However, because it has a cash reserve of ₹64.3m, its net debt is less, at about ₹200.3m.

How Strong Is Nila Spaces' Balance Sheet?

The latest balance sheet data shows that Nila Spaces had liabilities of ₹14.5m due within a year, and liabilities of ₹266.8m falling due after that. Offsetting these obligations, it had cash of ₹64.3m as well as receivables valued at ₹140.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹77.0m.

Since publicly traded Nila Spaces shares are worth a total of ₹697.2m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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 0.37 times and a disturbingly high net debt to EBITDA ratio of 12.5 hit our confidence in Nila Spaces like a one-two punch to the gut. The debt burden here is substantial. Worse, Nila Spaces's EBIT was down 85% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is Nila Spaces'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Nila Spaces actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Neither Nila Spaces's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Nila Spaces's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 3 warning signs for Nila Spaces you should be aware of, and 2 of them are significant.

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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