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.' 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 Ruchira Papers Limited (NSE:RUCHIRA) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Ruchira Papers

How Much Debt Does Ruchira Papers Carry?

You can click the graphic below for the historical numbers, but it shows that Ruchira Papers had ₹605.2m of debt in March 2019, down from ₹758.9m, one year before. However, because it has a cash reserve of ₹14.7m, its net debt is less, at about ₹590.5m.

How Healthy Is Ruchira Papers's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ruchira Papers had liabilities of ₹1.10b due within 12 months and liabilities of ₹562.2m due beyond that. On the other hand, it had cash of ₹14.7m and ₹917.1m worth of receivables due within a year. So its liabilities total ₹734.7m more than the combination of its cash and short-term receivables.

Ruchira Papers has a market capitalization of ₹1.71b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Ruchira Papers has net debt of just 0.73 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.6 times, which is more than adequate. Also good is that Ruchira Papers grew its EBIT at 16% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is Ruchira Papers's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Ruchira Papers 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

Ruchira Papers's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to grow its EBIT isn't too shabby at all. We think that Ruchira Papers's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Ruchira Papers's dividend history, without delay!

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.