United Spirits (NSE:MCDOWELL-N) appears to be using debt sparingly
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies United Spirits Limited (NSE:MCDOWELL-N) uses debt. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up 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 consider cash and debt levels, together.
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How much debt does United Spirits have?
You can click on the graph below for historical figures, but it shows United Spirits had ₹10.1 billion in debt in September 2021, up from ₹19.6 billion a year earlier. However, he has ₹639.0 million in cash to offset this, resulting in a net debt of around ₹9.44 billion.
How healthy is United Spirits’ balance sheet?
According to the latest published balance sheet, United Spirits had liabilities of ₹44.5 billion due within 12 months and liabilities of ₹2.06 billion due beyond 12 months. As compensation for these obligations, it had cash of ₹639.0 million as well as receivables valued at ₹26.4 billion due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of ₹19.5 billion.
Given that United Spirits has a market capitalization of ₹626.3 billion, it is hard to believe that these liabilities pose a big threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
United Spirits has a low net debt to EBITDA ratio of just 0.65. And its EBIT covers its interest charges 13.7 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. What is even more impressive is that United Spirits increased its EBIT by 117% year-over-year. This boost will make paying off debt even easier in the future. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine United Spirits’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a company can only repay its debts with cold hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, United Spirits has generated free cash flow of a very strong 88% of EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that United Spirits’ demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, since its conversion of EBIT into free cash flow also confirms this impression! It looks like United Spirits have no trouble holding their own and have no reason to fear their lenders. For investment nerds like us, his track record is almost charming. Over time, stock prices tend to track earnings per share, so if you’re interested in United Spirits, you might want to click here for an interactive chart of its earnings per share history.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.