Is Amara Raja Batteries (NSE:AMARAJABAT) Using Too Much Debt?

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. 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 can see that Amara Raja Batteries Limited (NSE:AMARAJABAT) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Amara Raja Batteries

What Is Amara Raja Batteries's Net Debt?

As you can see below, Amara Raja Batteries had ₹468.0m of debt at September 2019, down from ₹584.3m a year prior. But it also has ₹5.49b in cash to offset that, meaning it has ₹5.03b net cash.

A Look At Amara Raja Batteries's Liabilities

The latest balance sheet data shows that Amara Raja Batteries had liabilities of ₹11.0b due within a year, and liabilities of ₹2.63b falling due after that. Offsetting this, it had ₹5.49b in cash and ₹7.43b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹708.3m.

This state of affairs indicates that Amara Raja Batteries's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹118.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Amara Raja Batteries also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Amara Raja Batteries has been able to increase its EBIT by 20% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Amara Raja Batteries's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Amara Raja Batteries 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. Looking at the most recent three years, Amara Raja Batteries recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Amara Raja Batteries has ₹5.03b in net cash. And it impressed us with its EBIT growth of 20% over the last year. So is Amara Raja Batteries's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Amara Raja Batteries , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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