These 4 Measures Indicate That Morarjee Textiles (NSE:MORARJEE) Is Using Debt In A Risky Way

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Simply Wall St

Mon, Sep 23, 2019, 12:44 AM

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Morarjee Textiles Limited (NSE:MORARJEE) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Morarjee Textiles

What Is Morarjee Textiles's Net Debt?

As you can see below, Morarjee Textiles had ₹5.10b of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. Net debt is about the same, since the it doesn't have much cash.

NSEI:MORARJEE Historical Debt, September 23rd 2019

How Healthy Is Morarjee Textiles's Balance Sheet?

According to the last reported balance sheet, Morarjee Textiles had liabilities of ₹2.86b due within 12 months, and liabilities of ₹3.53b due beyond 12 months. Offsetting these obligations, it had cash of ₹95.5m as well as receivables valued at ₹719.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹5.58b.

The deficiency here weighs heavily on the ₹502.7m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet." So we definitely think shareholders need to watch this one closely. After all, Morarjee Textiles would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Morarjee Textiles shareholders face the double whammy of a high net debt to EBITDA ratio (9.8), and fairly weak interest coverage, since EBIT is just 0.54 times the interest expense. The debt burden here is substantial. Even worse, Morarjee Textiles saw its EBIT tank 30% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Morarjee Textiles will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Morarjee Textiles recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

To be frank both Morarjee Textiles's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think Morarjee Textiles has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. While Morarjee Textiles didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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