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. 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. As with many other companies Aksh Optifibre Limited (NSE:AKSHOPTFBR) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Aksh Optifibre Carry?
As you can see below, Aksh Optifibre had ₹2.69b of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have ₹186.6m in cash offsetting this, leading to net debt of about ₹2.50b.
How Healthy Is Aksh Optifibre's Balance Sheet?
According to the last reported balance sheet, Aksh Optifibre had liabilities of ₹3.68b due within 12 months, and liabilities of ₹1.42b due beyond 12 months. Offsetting this, it had ₹186.6m in cash and ₹1.98b in receivables that were due within 12 months. So its liabilities total ₹2.93b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the ₹1.39b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet." So we definitely think shareholders need to watch this one closely. At the end of the day, Aksh Optifibre would probably need a major re-capitalization if its creditors were to demand repayment.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While Aksh Optifibre's debt to EBITDA ratio (4.4) suggests that it uses some debt, its interest cover is very weak, at 1.0, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, Aksh Optifibre's EBIT was down 36% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Aksh Optifibre'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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Aksh Optifibre saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Aksh Optifibre's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its interest cover fails to inspire much confidence. Considering everything we've mentioned above, it's fair to say that Aksh Optifibre is carrying heavy debt load. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. Given the risks around Aksh Optifibre's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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