Is Parsvnath Developers (NSE:PARSVNATH) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Parsvnath Developers Limited (NSE:PARSVNATH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Parsvnath Developers

How Much Debt Does Parsvnath Developers Carry?

You can click the graphic below for the historical numbers, but it shows that Parsvnath Developers had ₹21.8b of debt in September 2020, down from ₹23.8b, one year before. On the flip side, it has ₹3.34b in cash leading to net debt of about ₹18.5b.

How Strong Is Parsvnath Developers's Balance Sheet?

The latest balance sheet data shows that Parsvnath Developers had liabilities of ₹51.8b due within a year, and liabilities of ₹26.6b falling due after that. Offsetting these obligations, it had cash of ₹3.34b as well as receivables valued at ₹3.24b due within 12 months. So it has liabilities totalling ₹71.8b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₹2.04b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Parsvnath Developers 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.14 times and a disturbingly high net debt to EBITDA ratio of 23.6 hit our confidence in Parsvnath Developers like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Parsvnath Developers achieved a positive EBIT of ₹564m in the last twelve months, an improvement on the prior year's loss. 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 Parsvnath Developers 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Parsvnath Developers's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Parsvnath Developers's interest cover 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. But at least its conversion of EBIT to free cash flow is not so bad. Overall, it seems to us that Parsvnath Developers's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 Parsvnath Developers you should be aware of, and 1 of them is potentially serious.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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