Does Panache Digilife (NSE:PANACHE) Have A Healthy Balance Sheet?

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 Panache Digilife Limited (NSE:PANACHE) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Panache Digilife

What Is Panache Digilife's Debt?

The image below, which you can click on for greater detail, shows that Panache Digilife had debt of ₹241.2m at the end of March 2022, a reduction from ₹285.9m over a year. However, because it has a cash reserve of ₹9.07m, its net debt is less, at about ₹232.1m.

How Healthy Is Panache Digilife's Balance Sheet?

According to the last reported balance sheet, Panache Digilife had liabilities of ₹609.1m due within 12 months, and liabilities of ₹55.8m due beyond 12 months. On the other hand, it had cash of ₹9.07m and ₹316.3m worth of receivables due within a year. So it has liabilities totalling ₹339.5m more than its cash and near-term receivables, combined.

Panache Digilife has a market capitalization of ₹736.8m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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 we wouldn't worry about Panache Digilife's net debt to EBITDA ratio of 3.5, we think its super-low interest cover of 1.8 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. On a lighter note, we note that Panache Digilife grew its EBIT by 26% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Panache Digilife'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Panache Digilife recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Neither Panache Digilife's ability to cover its interest expense with its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Panache Digilife's debt poses some risks to the business. 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. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Panache Digilife (of which 3 are a bit unpleasant!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.