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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. 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. We note that Arvind Limited (NSE:ARVIND) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Arvind
How Much Debt Does Arvind Carry?
As you can see below, Arvind had ₹27.0b of debt at March 2019, down from ₹33.3b a year prior. However, it does have ₹958.2m in cash offsetting this, leading to net debt of about ₹26.1b.
How Healthy Is Arvind's Balance Sheet?
The latest balance sheet data shows that Arvind had liabilities of ₹34.1b due within a year, and liabilities of ₹10.9b falling due after that. Offsetting these obligations, it had cash of ₹958.2m as well as receivables valued at ₹12.1b due within 12 months. So its liabilities total ₹31.9b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the ₹12.1b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, Arvind would probably need a major re-capitalization if its creditors were to demand repayment.
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 Arvind's debt to EBITDA ratio (3.8) suggests that it uses some debt, its interest cover is very weak, at 2.3, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, Arvind saw its EBIT tank 32% 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 ultimately the future profitability of the business will decide if Arvind can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.