Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘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. We note that Zodiac Clothing Company Limited (NSE:ZODIACLOTH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Zodiac Clothing
How Much Debt Does Zodiac Clothing Carry?
The image below, which you can click on for greater detail, shows that Zodiac Clothing had debt of ₹427.2m at the end of September 2021, a reduction from ₹620.9m over a year. However, it does have ₹136.5m in cash offsetting this, leading to net debt of about ₹290.7m.
A Look At Zodiac Clothing’s Liabilities
We can see from the most recent balance sheet that Zodiac Clothing had liabilities of ₹796.3m falling due within a year, and liabilities of ₹344.7m due beyond that. Offsetting these obligations, it had cash of ₹136.5m as well as receivables valued at ₹315.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹689.2m.
While this might seem like a lot, it is not so bad since Zodiac Clothing has a market capitalization of ₹2.74b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Zodiac Clothing will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Zodiac Clothing made a loss at the EBIT level, and saw its revenue drop to ₹1.1b, which is a fall of 17%. That’s not what we would hope to see.
Not only did Zodiac Clothing’s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping ₹373m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled ₹103m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we’ve identified 3 warning signs for Zodiac Clothing (1 is potentially serious) you should be aware of.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.