We Think Oberoi Realty (NSE:OBEROIRLTY) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Oberoi Realty Limited (NSE:OBEROIRLTY) makes use of debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

View our latest analysis for Oberoi Realty

How Much Debt Does Oberoi Realty Carry?

You can click the graphic below for the historical numbers, but it shows that Oberoi Realty had ₹13.9b of debt in September 2020, down from ₹20.2b, one year before. However, because it has a cash reserve of ₹4.06b, its net debt is less, at about ₹9.83b.

How Healthy Is Oberoi Realty's Balance Sheet?

The latest balance sheet data shows that Oberoi Realty had liabilities of ₹25.1b due within a year, and liabilities of ₹1.88b falling due after that. Offsetting these obligations, it had cash of ₹4.06b as well as receivables valued at ₹4.62b due within 12 months. So it has liabilities totalling ₹18.3b more than its cash and near-term receivables, combined.

Of course, Oberoi Realty has a market capitalization of ₹168.5b, so these liabilities are probably manageable. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Oberoi Realty's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 21.7 times the size. So we're pretty relaxed about its super-conservative use of debt. Oberoi Realty's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Oberoi Realty's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. During the last three years, Oberoi Realty burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Oberoi Realty's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Oberoi Realty's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Over time, share prices tend to follow earnings per share, so if you're interested in Oberoi Realty, you may well want to click here to check an interactive graph of its earnings per share history.

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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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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