Here’s why Dollar Industries (NSE:DOLLAR) can manage its debt responsibly
Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Dollar Industries Limited (NSE:DOLLAR) uses debt in its business. 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. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest analysis for Dollar Industries
What is Dollar Industries net debt?
You can click on the graph below for historical figures, but it shows that as of September 2021, Dollar Industries had debt of ₹1.69 billion, an increase from ₹1.29 billion, on a year. However, since he has a cash reserve of ₹86.7 million, his net debt is lower at around ₹1.60 billion.
How strong is Dollar Industries’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Dollar Industries had liabilities of ₹3.93 billion due within 12 months and liabilities of ₹81.3 million due beyond. In return, he had ₹86.7 million in cash and ₹3.79 billion in receivables due within 12 months. Thus, its liabilities total £133.2 million more than the combination of its cash and short-term receivables.
Considering the size of Dollar Industries, it looks like its cash is well balanced with its total liabilities. It is therefore highly unlikely that the ₹31.4bn company will run out of cash, but it is still worth keeping an eye on the balance sheet.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Dollar Industries has a low net debt to EBITDA ratio of just 0.84. And its EBIT covers its interest charges 32.5 times. So we’re pretty relaxed about his super-conservative use of debt. On top of that, we are pleased to report that Dollar Industries increased its EBIT by 57%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Dollar Industries will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Dollar Industries has recorded free cash flow of 29% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.
Our point of view
The good news is that Dollar Industries’ demonstrated ability to cover interest costs with EBIT delights us like a fluffy puppy does a toddler. But, on a darker note, we are a bit concerned about its conversion of EBIT into free cash flow. Zooming out, Dollar Industries seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that Dollar Industries displays 2 warning signs in our investment analysis you should know…
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.