David Iben put it right when he said, “Volatility is not a risk we care about. What we care about is avoiding permanent capital loss. So it seems like the smart money knows that debt – which is usually involved in bankruptcy – is a very important factor when judging how risky a business is. We note that Amber Enterprises India Limited NSE: AMBER) does have debts on the balance sheet. But the real question is whether this debt makes the business risky.
Why does debt involve risks?
Debt helps a business until it struggles to pay it off, either with new capital or with free cash flow. An essential part of capitalism is the process of ‘creative destruction’, where failed companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, permanently diluting shareholders. Of course, the benefit of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high returns. The first step in considering a company’s debt levels is to consider the cash and debt together.
How Much Debt Does Amber Enterprises India Bear?
As you can see below, Amber Enterprises India had € 4.19 billion in debt at the end of September 2020, up from € 3.80 billion a year ago. Click on the image for more details. On the other hand, it has ₹ 3.08 billion in cash leading to a net debt of approximately ₹ 1.11 billion.
A look at the commitments of Amber Enterprises India
We can see from the most recent balance sheet that Amber Enterprises India had liabilities of ₹ 7.59 billion maturing within one year and liabilities of ₹ 1.96 billion maturing thereafter. To compensate for this, it had ₹ 3.08 billion in cash and ₹ 3.60 billion in receivables due in 12 months. Thus, his liabilities total ₹ 2.88 billion more than the combination of his cash and receivables.
Since the publicly traded shares of Amber Enterprises India are worth a total of ₹ 106.5 billion, it seems unlikely that this level of liabilities would pose a major threat. However, we think it is worth keeping an eye on the strength of the balance as it can change over time. Amber Enterprises India has virtually no net debt and is indeed very light in debt.
To match a company’s debt to income, we calculate net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA) and earnings before interest and taxes (EBIT) divided by interest expense (its interest coverage) . In this way, we look at both the absolute amount of the debt and the interest rates paid on it.
While Amber Enterprises India’s low debt / EBITDA ratio of 0.61 suggests only modest use of debt, the fact that EBIT covered just 3.4 times interest expense last year gives us a pause. But the interest payments are certainly enough to make us think about how affordable his debt is. Shareholders should be aware that Amber Enterprises India’s EBIT was down 56% last year. If that income trend continues, paying off his debt will be about as easy as herding cats on a roller coaster. When analyzing debt levels, balance sheet is the obvious place to start. Ultimately, however, the company’s future profitability will decide whether Amber Enterprises India can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst earnings expectations are interesting.
Finally, a company needs free cash flow to pay off debts; accounting profits just don’t cut it. So it’s worth checking how much of that EBIT is backed by free cash flow. Amber Enterprises India has seen significant negative free cash flow overall over the past three years. While investors no doubt expect that situation to be reversed in due course, it clearly means that using debt is more risky.
To be fair, both Amber Enterprises India’s conversion of EBIT to free cash flow and the track record of (not) growing EBIT make us quite uncomfortable with debt levels. But on the upside, net debt to EBITDA is a good sign and makes us more optimistic. Looking at all of the above factors together, it seems to us that Amber Enterprises India’s debt makes it a bit risky. Some people like that kind of risk, but we are aware of the potential pitfalls, so we probably prefer less debt. When analyzing debt levels, balance sheet is the obvious place to start. However, not all investment risks are in the balance sheet – far from it. For example, we have identified 3 warning signs for Amber Enterprises India which you should be aware of.
At the end of the day, it is often better to focus on companies that are free of net debt. You have access to our special list of such companies (all with a track record of earnings growth). It is free.
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This article from Simply Wall St is general in nature. It is not a recommendation to buy or sell stock and does not take into account your objectives or your financial situation. We strive to provide you with long-term focused analysis powered by fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality material. Simply Wall St has no exposure to said stocks.
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