Here's Why Prestige Estates Projects (NSE:PRESTIGE) Is Weighed Down By Its Debt Load

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.' 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. As with many other companies Prestige Estates Projects Limited (NSE:PRESTIGE) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Prestige Estates Projects

What Is Prestige Estates Projects's Debt?

As you can see below, Prestige Estates Projects had ₹85.5b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₹6.91b in cash leading to net debt of about ₹78.6b.

How Healthy Is Prestige Estates Projects' Balance Sheet?

The latest balance sheet data shows that Prestige Estates Projects had liabilities of ₹156.0b due within a year, and liabilities of ₹79.5b falling due after that. Offsetting these obligations, it had cash of ₹6.91b as well as receivables valued at ₹26.1b due within 12 months. So it has liabilities totalling ₹202.5b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₹111.3b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Prestige Estates Projects would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Prestige Estates Projects's debt to EBITDA ratio (4.5) suggests that it uses some debt, its interest cover is very weak, at 1.5, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, Prestige Estates Projects saw its EBIT tank 27% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that 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 Prestige Estates Projects's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Looking at the most recent three years, Prestige Estates Projects recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Prestige Estates Projects's EBIT growth rate 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 convert EBIT to free cash flow isn't such a worry. Taking into account all the aforementioned factors, it looks like Prestige Estates Projects has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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 3 warning signs for Prestige Estates Projects you should be aware of, and 1 of them makes us a bit uncomfortable.

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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