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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Century Textiles and Industries Limited (NSE:CENTURYTEX) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Century Textiles and Industries
How Much Debt Does Century Textiles and Industries Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2022 Century Textiles and Industries had ₹13.2b of debt, an increase on ₹10.3b, over one year. However, because it has a cash reserve of ₹2.45b, its net debt is less, at about ₹10.7b.
How Strong Is Century Textiles and Industries’ Balance Sheet?
We can see from the most recent balance sheet that Century Textiles and Industries had liabilities of ₹28.4b falling due within a year, and liabilities of ₹10.2b due beyond that. Offsetting these obligations, it had cash of ₹2.45b as well as receivables valued at ₹2.17b due within 12 months. So it has liabilities totalling ₹34.0b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Century Textiles and Industries has a market capitalization of ₹85.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Century Textiles and Industries’s net debt is sitting at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest expense just 4.1 times last year. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. Notably, Century Textiles and Industries’s EBIT launched higher than Elon Musk, gaining a whopping 534,525% on last year. There’s no doubt that we learn most about debt from the balance sheet. But it is Century Textiles and Industries’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Century Textiles and Industries reported free cash flow worth 12% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Our View
On our analysis Century Textiles and Industries’s EBIT growth rate should signal that it won’t have too much trouble with its debt. But the other factors we noted above weren’t so encouraging. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. Looking at all this data makes us feel a little cautious about Century Textiles and Industries’s debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. For example Century Textiles and Industries has 2 warning signs (and 1 which is a bit concerning) we think you should know about.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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