We Think Birla Cable (NSE:BIRLACABLE) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Birla Cable Limited (NSE:BIRLACABLE) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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.

View our latest analysis for Birla Cable

What Is Birla Cable's Debt?

You can click the graphic below for the historical numbers, but it shows that Birla Cable had ₹476.2m of debt in September 2020, down from ₹1.11b, one year before. However, it also had ₹95.8m in cash, and so its net debt is ₹380.4m.

A Look At Birla Cable's Liabilities

The latest balance sheet data shows that Birla Cable had liabilities of ₹869.2m due within a year, and liabilities of ₹228.9m falling due after that. On the other hand, it had cash of ₹95.8m and ₹961.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹40.8m.

Having regard to Birla Cable's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹2.17b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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.

Birla Cable's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 3.0 times last year. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. Shareholders should be aware that Birla Cable's EBIT was down 45% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is Birla Cable'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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Birla Cable recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Birla Cable's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its level of total liabilities is relatively strong. When we consider all the factors discussed, it seems to us that Birla Cable is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Birla Cable , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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