Eicher Motors (NSE:EICHERMOT) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Eicher Motors Limited (NSE:EICHERMOT) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Eicher Motors

What Is Eicher Motors's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Eicher Motors had debt of ₹1.57b, up from ₹1.44b in one year. But it also has ₹71.2b in cash to offset that, meaning it has ₹69.6b net cash.

How Strong Is Eicher Motors' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Eicher Motors had liabilities of ₹26.3b due within 12 months and liabilities of ₹4.92b due beyond that. Offsetting this, it had ₹71.2b in cash and ₹6.17b in receivables that were due within 12 months. So it can boast ₹46.2b more liquid assets than total liabilities.

This surplus suggests that Eicher Motors has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Eicher Motors has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Eicher Motors if management cannot prevent a repeat of the 29% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Eicher Motors can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Eicher Motors 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, Eicher Motors produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Eicher Motors has net cash of ₹69.6b, as well as more liquid assets than liabilities. So we are not troubled with Eicher Motors's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Eicher Motors insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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