Hero MotoCorp (NSE:HEROMOTOCO) Seems To Use Debt Quite Sensibly

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, Hero MotoCorp Limited (NSE:HEROMOTOCO) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hero MotoCorp

What Is Hero MotoCorp's Debt?

As you can see below, at the end of September 2022, Hero MotoCorp had ₹4.68b of debt, up from ₹3.89b a year ago. Click the image for more detail. But it also has ₹47.3b in cash to offset that, meaning it has ₹42.6b net cash.

How Healthy Is Hero MotoCorp's Balance Sheet?

We can see from the most recent balance sheet that Hero MotoCorp had liabilities of ₹66.3b falling due within a year, and liabilities of ₹10.4b due beyond that. On the other hand, it had cash of ₹47.3b and ₹40.3b worth of receivables due within a year. So it actually has ₹10.9b more liquid assets than total liabilities.

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

On the other hand, Hero MotoCorp's EBIT dived 11%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hero MotoCorp'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Hero MotoCorp may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Hero MotoCorp recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hero MotoCorp has ₹42.6b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹21b, being 81% of its EBIT. So we don't think Hero MotoCorp's use of debt is risky. 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. For instance, we've identified 2 warning signs for Hero MotoCorp (1 is concerning) you should be aware of.

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.

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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.