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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.' 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. Importantly, Ambika Cotton Mills Limited (NSE:AMBIKCO) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Ambika Cotton Mills
What Is Ambika Cotton Mills's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2019 Ambika Cotton Mills had debt of ₹886.7m, up from ₹284.3m in one year. On the flip side, it has ₹466.9m in cash leading to net debt of about ₹419.8m.
A Look At Ambika Cotton Mills's Liabilities
The latest balance sheet data shows that Ambika Cotton Mills had liabilities of ₹1.04b due within a year, and liabilities of ₹349.9m falling due after that. Offsetting this, it had ₹466.9m in cash and ₹125.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹793.8m.
Of course, Ambika Cotton Mills has a market capitalization of ₹4.91b, 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.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Ambika Cotton Mills has net debt of just 0.34 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.4 times, which is more than adequate. The good news is that Ambika Cotton Mills has increased its EBIT by 9.4% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ambika Cotton Mills will need earnings to service that debt. 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.