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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Blue Star Limited (NSE:BLUESTARCO) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Blue Star
What Is Blue Star's Debt?
The image below, which you can click on for greater detail, shows that Blue Star had debt of ₹3.48b at the end of March 2019, a reduction from ₹3.76b over a year. On the flip side, it has ₹838.6m in cash leading to net debt of about ₹2.64b.
How Strong Is Blue Star's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Blue Star had liabilities of ₹24.5b due within 12 months and liabilities of ₹271.6m due beyond that. Offsetting these obligations, it had cash of ₹838.6m as well as receivables valued at ₹15.3b due within 12 months. So it has liabilities totalling ₹8.58b more than its cash and near-term receivables, combined.
Of course, Blue Star has a market capitalization of ₹74.2b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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.
Blue Star's net debt is only 0.82 times its EBITDA. And its EBIT covers its interest expense a whopping 12.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Blue Star grew its EBIT by 7.9% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Blue Star can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.