Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies HeidelbergCement India Limited (NSE:HEIDELBERG) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does HeidelbergCement India Carry?
As you can see below, HeidelbergCement India had ₹3.92b of debt at March 2019, down from ₹6.19b a year prior. However, it does have ₹3.38b in cash offsetting this, leading to net debt of about ₹541.5m.
How Healthy Is HeidelbergCement India’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that HeidelbergCement India had liabilities of ₹9.13b due within 12 months and liabilities of ₹6.11b due beyond that. Offsetting these obligations, it had cash of ₹3.38b as well as receivables valued at ₹280.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹11.6b.
While this might seem like a lot, it is not so bad since HeidelbergCement India has a market capitalization of ₹45.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. But either way, HeidelbergCement India has virtually no net debt, so it’s fair to say it does not have a heavy debt load!
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While HeidelbergCement India’s low debt to EBITDA ratio of 0.11 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.1 last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. It is well worth noting that HeidelbergCement India’s EBIT shot up like bamboo after rain, gaining 42% in the last twelve months. That’ll make it easier to manage its debt. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine HeidelbergCement India’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, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, HeidelbergCement India actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
The good news is that HeidelbergCement India’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that’s just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, HeidelbergCement India seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you’ve also come to that realization, you’re in luck, because today you can view this interactive graph of HeidelbergCement India’s earnings per share history for free.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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