We Think Butterfly Gandhimathi Appliances (NSE:BUTTERFLY) Is Taking Some Risk With Its Debt
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. We note that Butterfly Gandhimathi Appliances Limited (NSE:BUTTERFLY) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Butterfly Gandhimathi Appliances
How Much Debt Does Butterfly Gandhimathi Appliances Carry?
You can click the graphic below for the historical numbers, but it shows that Butterfly Gandhimathi Appliances had ₹1.54b of debt in March 2019, down from ₹1.89b, one year before. However, it also had ₹32.8m in cash, and so its net debt is ₹1.51b.
A Look At Butterfly Gandhimathi Appliances's Liabilities
According to the last reported balance sheet, Butterfly Gandhimathi Appliances had liabilities of ₹2.32b due within 12 months, and liabilities of ₹421.8m due beyond 12 months. Offsetting these obligations, it had cash of ₹32.8m as well as receivables valued at ₹1.21b due within 12 months. So its liabilities total ₹1.51b more than the combination of its cash and short-term receivables.
Butterfly Gandhimathi Appliances has a market capitalization of ₹2.65b, 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 use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 Butterfly Gandhimathi Appliances's debt to EBITDA ratio (3.2) suggests that it uses some debt, its interest cover is very weak, at 1.8, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Fortunately, Butterfly Gandhimathi Appliances grew its EBIT by 4.6% 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 it is future earnings, more than anything, that will determine Butterfly Gandhimathi Appliances's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent two years, Butterfly Gandhimathi Appliances recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Our View
Butterfly Gandhimathi Appliances's interest cover was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its conversion of EBIT to free cash flow was refreshing. Looking at all the angles mentioned above, it does seem to us that Butterfly Gandhimathi Appliances is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Over time, share prices tend to follow earnings per share, so if you're interested in Butterfly Gandhimathi Appliances, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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.
