Legendary fund manager Li Lu (who Charlie Munger supported) once said, âThe biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. Above all, United Spirits Limited (NSE: MCDOWELL-N) is in debt. But does this debt worry shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first look at cash and debt levels, together.
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What is the debt of United Spirits?
The image below, which you can click for more details, shows United Spirits owed 7.71 billion yen at the end of September 2021, a reduction from the 17.9 billion yen on a year. However, given that it has a cash reserve of 639.0 million yen, its net debt is less, at around 7.07 billion yen.
A look at the responsibilities of United Spirits
Zooming in on the latest balance sheet data, we can see that United Spirits had liabilities of 44.5 billion yen due within 12 months and liabilities of 2.06 billion yen due beyond. In compensation for these obligations, it had cash of 639.0 million as well as receivables valued at 26.4 billion maturing within 12 months. It therefore has liabilities totaling 19.5 billion yen more than its cash and short-term receivables combined.
Of course, United Spirits has a market cap of 670.6 billion yen, so this liability is probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time. But in any case, United Spirits has virtually no net debt, so it’s fair to say that they don’t have a lot of debt!
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). Thus, we consider debt versus earnings with and without amortization expenses.
United Spirits’ net debt is only 0.50 times its EBITDA. And its EBIT easily covers its interest costs, being 12.5 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Even more impressively, United Spirits increased its EBIT by 113% year over year. This boost will make it even easier to pay down debt in the future. The balance sheet is clearly the area to focus on when analyzing debt. But it is future profits, more than anything, that will determine United Spirits’ ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts‘ earnings forecasts.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, United Spirits has generated strong free cash flow equivalent to 80% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
United Spirits’ interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And that’s just the start of good news as its EBIT growth rate is also very encouraging. We believe that United Spirits owe no more to their lenders than the birds are to bird watchers. For investment nerds like us, his record is almost charming. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example – United Spirits has 1 warning sign we think you should be aware.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow-growing stocks.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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