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. Importantly, Salona Cotspin Limited (NSE:SALONACOT) does carry debt. But the more important question is: how much risk is that debt creating?
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. 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. 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.
View our latest analysis for Salona Cotspin
How Much Debt Does Salona Cotspin Carry?
As you can see below, at the end of March 2019, Salona Cotspin had ₹476.4m of debt, up from ₹433.4m a year ago. Click the image for more detail. However, because it has a cash reserve of ₹17.2m, its net debt is less, at about ₹459.2m.
How Healthy Is Salona Cotspin's Balance Sheet?
We can see from the most recent balance sheet that Salona Cotspin had liabilities of ₹485.3m falling due within a year, and liabilities of ₹100.5m due beyond that. Offsetting this, it had ₹17.2m in cash and ₹226.6m in receivables that were due within 12 months. So it has liabilities totalling ₹341.9m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of ₹375.9m, so it does suggest shareholders should keep an eye on Salona Cotspin's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While we wouldn't worry about Salona Cotspin's net debt to EBITDA ratio of 4.7, we think its super-low interest cover of 1.5 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Fortunately, Salona Cotspin grew its EBIT by 9.4% in the last year, slowly shrinking its debt relative to earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Salona Cotspin 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.