Hero MotoCorp (NSE:HEROMOTOCO) 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. As with many other companies Hero MotoCorp Limited (NSE:HEROMOTOCO) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hero MotoCorp

How Much Debt Does Hero MotoCorp Carry?

As you can see below, Hero MotoCorp had ₹3.53b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₹61.7b in cash offsetting this, leading to net cash of ₹58.2b.

How Strong Is Hero MotoCorp's Balance Sheet?

The latest balance sheet data shows that Hero MotoCorp had liabilities of ₹55.2b due within a year, and liabilities of ₹9.66b falling due after that. Offsetting these obligations, it had cash of ₹61.7b as well as receivables valued at ₹21.8b due within 12 months. So it actually has ₹18.7b more liquid assets than total liabilities.

This short term liquidity is a sign that Hero MotoCorp could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hero MotoCorp boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Hero MotoCorp's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hero MotoCorp's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hero MotoCorp 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, Hero MotoCorp recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Hero MotoCorp has net cash of ₹58.2b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₹15b, being 99% of its EBIT. So we are not troubled with Hero MotoCorp's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Hero MotoCorp you should be aware of, and 1 of them is significant.

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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.