Here's Why Cantabil Retail India (NSE:CANTABIL) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Cantabil Retail India Limited (NSE:CANTABIL) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Cantabil Retail India

What Is Cantabil Retail India's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Cantabil Retail India had ₹388.5m of debt in March 2019, down from ₹432.9m, one year before. However, because it has a cash reserve of ₹68.1m, its net debt is less, at about ₹320.4m.

NSEI:CANTABIL Historical Debt, August 20th 2019
NSEI:CANTABIL Historical Debt, August 20th 2019

How Healthy Is Cantabil Retail India's Balance Sheet?

According to the last reported balance sheet, Cantabil Retail India had liabilities of ₹955.2m due within 12 months, and liabilities of ₹153.1m due beyond 12 months. On the other hand, it had cash of ₹68.1m and ₹190.1m worth of receivables due within a year. So its liabilities total ₹850.1m more than the combination of its cash and short-term receivables.

Cantabil Retail India has a market capitalization of ₹3.65b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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). 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).

Given net debt is only 0.72 times EBITDA, it is initially surprising to see that Cantabil Retail India's EBIT has low interest coverage of 2.1 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Pleasingly, Cantabil Retail India is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 126% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Cantabil Retail India'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Cantabil Retail India actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

When it comes to the balance sheet, the standout positive for Cantabil Retail India was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. In particular, interest cover gives us cold feet. When we consider all the factors mentioned above, we do feel a bit cautious about Cantabil Retail India's use of debt. 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. Over time, share prices tend to follow earnings per share, so if you're interested in Cantabil Retail India, you may well want to click here to check an interactive graph of its earnings per share history.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.