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.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Polycab India Limited (NSE:POLYCAB) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Polycab India’s Debt?
You can click the graphic below for the historical numbers, but it shows that Polycab India had ₹2.72b of debt in March 2019, down from ₹8.00b, one year before. However, its balance sheet shows it holds ₹3.18b in cash, so it actually has ₹458.2m net cash.
A Look At Polycab India’s Liabilities
Zooming in on the latest balance sheet data, we can see that Polycab India had liabilities of ₹26.2b due within 12 months and liabilities of ₹1.54b due beyond that. Offsetting this, it had ₹3.18b in cash and ₹14.2b in receivables that were due within 12 months. So it has liabilities totalling ₹10.3b more than its cash and near-term receivables, combined.
Since publicly traded Polycab India shares are worth a total of ₹85.4b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Polycab India also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Also good is that Polycab India grew its EBIT at 19% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Polycab 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Polycab India has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Polycab India produced sturdy free cash flow equating to 68% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Polycab India does have more liabilities than liquid assets, it also has net cash of ₹458m. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in ₹9.4b. So we don’t think Polycab India’s use of debt is risky. 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 Polycab India’s earnings per share history for free.
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.
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