David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Eicher Motors Limited (NSE:EICHERMOT) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View 2 warning signs we detected for Eicher Motors
What Is Eicher Motors's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Eicher Motors had ₹1.64b of debt, an increase on ₹1.7k, over one year. But on the other hand it also has ₹35.7b in cash, leading to a ₹34.1b net cash position.
How Strong Is Eicher Motors's Balance Sheet?
The latest balance sheet data shows that Eicher Motors had liabilities of ₹20.7b due within a year, and liabilities of ₹3.94b falling due after that. On the other hand, it had cash of ₹35.7b and ₹1.28b worth of receivables due within a year. So it actually has ₹12.3b more liquid assets than total liabilities.
This short term liquidity is a sign that Eicher Motors could probably pay off its debt with ease, as its balance sheet is far from stretched. 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 21% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Eicher Motors'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 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. Looking at the most recent three years, Eicher Motors recorded free cash flow of 48% 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 investigate a company's debt, in this case Eicher Motors has ₹34.1b in net cash and a decent-looking balance sheet. So we don't have any problem with Eicher Motors's use of debt. 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, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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