Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies PVI limited (NSE:IVP) uses debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for IVP
What is IVP’s debt?
The image below, which you can click on for more details, shows that as of September 2021, IVP had a debt of ₹1.42 billion, up from ₹987.2 million in a year. However, he has ₹42.1 million in cash to offset this, resulting in a net debt of around ₹1.37 billion.
How strong is IVP’s balance sheet?
According to the latest published balance sheet, IVP had liabilities of ₹2.58 billion due within 12 months and liabilities of ₹7.80 million due beyond 12 months. As compensation for these obligations, it had cash of ₹42.1 million as well as receivables valued at ₹1.75 billion due within 12 months. It therefore has liabilities totaling ₹799.7 million more than its cash and short-term receivables, combined.
While that might sound like a lot, it’s not that bad since IVP has a market capitalization of ₹1.46 billion, and so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it must be carefully examined whether he can manage his debt without dilution.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
IVP has a debt to EBITDA ratio of 4.9 and its EBIT covered its interest expense 2.9 times. This suggests that while debt levels are significant, we will refrain from labeling them problematic. A redeeming factor for IVP is that it turned last year’s EBIT loss into a ₹233m gain, over the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But it is the profits of IVP that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, IVP has experienced substantial negative free cash flow, in total. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
We would go so far as to say that the conversion of EBIT to free cash flow by IVP was disappointing. But at least its EBIT growth rate isn’t that bad. We are very clear that we consider IVP to be really quite risky, given the health of its balance sheet. We are therefore almost as suspicious of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that IVP displays 5 warning signs in our investment analysis and 3 of them should not be ignored…
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.