These 4 Measures Indicate That Atul Auto (NSE:ATULAUTO) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Atul Auto Limited (NSE:ATULAUTO) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Atul Auto

What Is Atul Auto's Net Debt?

As you can see below, at the end of September 2020, Atul Auto had ₹150.0m of debt, up from ₹21.2m a year ago. Click the image for more detail. But it also has ₹427.4m in cash to offset that, meaning it has ₹277.4m net cash.

How Strong Is Atul Auto's Balance Sheet?

According to the last reported balance sheet, Atul Auto had liabilities of ₹676.6m due within 12 months, and liabilities of ₹169.1m due beyond 12 months. Offsetting this, it had ₹427.4m in cash and ₹285.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹132.6m.

Given Atul Auto has a market capitalization of ₹4.19b, it's hard to believe these liabilities pose much 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, Atul Auto also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Atul Auto's load is not too heavy, because its EBIT was down 74% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Atul Auto 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Atul Auto 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. Over the last three years, Atul Auto saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Atul Auto has ₹277.4m in net cash. So while Atul Auto does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Atul Auto you should be aware of.

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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