Does Archies (NSE:ARCHIES) Have A Healthy Balance Sheet?

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.' 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 Archies Limited (NSE:ARCHIES) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Archies

What Is Archies's Debt?

You can click the graphic below for the historical numbers, but it shows that Archies had ₹178.4m of debt in March 2021, down from ₹283.2m, one year before. However, it does have ₹10.5m in cash offsetting this, leading to net debt of about ₹167.9m.

How Strong Is Archies' Balance Sheet?

According to the last reported balance sheet, Archies had liabilities of ₹459.8m due within 12 months, and liabilities of ₹363.8m due beyond 12 months. Offsetting these obligations, it had cash of ₹10.5m as well as receivables valued at ₹107.7m due within 12 months. So it has liabilities totalling ₹705.4m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₹717.8m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Archies has a very low debt to EBITDA ratio of 0.82 so it is strange to see weak interest coverage, with last year's EBIT being only 0.46 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. We also note that Archies improved its EBIT from a last year's loss to a positive ₹34m. There's no doubt that we learn most about debt from the balance sheet. But it is Archies's earnings that will influence how the balance sheet holds up in the future. 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.

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. Over the last year, Archies actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Archies's interest cover and level of total liabilities definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. We think that Archies's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example, we've discovered 3 warning signs for Archies (2 make us uncomfortable!) that you should be aware of before investing here.

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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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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