Coffee Day Enterprises (NSE:COFFEEDAY) Use Of Debt Could Be Considered Risky

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Simply Wall St

Tue, Sep 24, 2019, 9:11 PM

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Coffee Day Enterprises Limited (NSE:COFFEEDAY) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Coffee Day Enterprises

How Much Debt Does Coffee Day Enterprises Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2019 Coffee Day Enterprises had ₹65.5b of debt, an increase on ₹50.8b, over one year. However, because it has a cash reserve of ₹26.0b, its net debt is less, at about ₹39.4b.

NSEI:COFFEEDAY Historical Debt, September 25th 2019

A Look At Coffee Day Enterprises's Liabilities

According to the last reported balance sheet, Coffee Day Enterprises had liabilities of ₹52.5b due within 12 months, and liabilities of ₹28.4b due beyond 12 months. Offsetting this, it had ₹26.0b in cash and ₹15.7b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹39.2b.

This deficit casts a shadow over the ₹13.1b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Coffee Day Enterprises 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.1 times and a disturbingly high net debt to EBITDA ratio of 5.4 hit our confidence in Coffee Day Enterprises like a one-two punch to the gut. The debt burden here is substantial. On a slightly more positive note, Coffee Day Enterprises grew its EBIT at 14% over the last year, further increasing its ability to manage 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 Coffee Day Enterprises 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.

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. Over the last three years, Coffee Day Enterprises 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 and improvement.

Our View

On the face of it, Coffee Day Enterprises's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Taking into account all the aforementioned factors, it looks like Coffee Day Enterprises has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Given the risks around Coffee Day Enterprises's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

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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