Snowman Logistics (NSE:SNOWMAN) Seems To Use Debt Quite Sensibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Snowman Logistics Limited (NSE:SNOWMAN) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Snowman Logistics

What Is Snowman Logistics's Net Debt?

The image below, which you can click on for greater detail, shows that Snowman Logistics had debt of ₹498.2m at the end of September 2020, a reduction from ₹783.6m over a year. On the flip side, it has ₹232.3m in cash leading to net debt of about ₹265.9m.

A Look At Snowman Logistics's Liabilities

The latest balance sheet data shows that Snowman Logistics had liabilities of ₹393.5m due within a year, and liabilities of ₹1.76b falling due after that. On the other hand, it had cash of ₹232.3m and ₹509.8m worth of receivables due within a year. So its liabilities total ₹1.41b more than the combination of its cash and short-term receivables.

Of course, Snowman Logistics has a market capitalization of ₹10.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Given net debt is only 0.52 times EBITDA, it is initially surprising to see that Snowman Logistics's EBIT has low interest coverage of 0.62 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that Snowman Logistics's EBIT was down 39% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is Snowman Logistics'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Snowman Logistics actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We weren't impressed with Snowman Logistics's interest cover, and its EBIT growth rate made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble converting EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Snowman Logistics's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 2 warning signs for Snowman Logistics you should be aware of, and 1 of them is concerning.

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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