Is Mahindra CIE Automotive (NSE:MAHINDCIE) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Mahindra CIE Automotive Limited (NSE:MAHINDCIE) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Mahindra CIE Automotive

What Is Mahindra CIE Automotive's Net Debt?

As you can see below, Mahindra CIE Automotive had ₹12.2b of debt at June 2022, down from ₹12.7b a year prior. However, because it has a cash reserve of ₹1.66b, its net debt is less, at about ₹10.5b.

How Healthy Is Mahindra CIE Automotive's Balance Sheet?

According to the last reported balance sheet, Mahindra CIE Automotive had liabilities of ₹35.3b due within 12 months, and liabilities of ₹15.6b due beyond 12 months. Offsetting these obligations, it had cash of ₹1.66b as well as receivables valued at ₹12.8b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹36.4b.

Mahindra CIE Automotive has a market capitalization of ₹110.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Mahindra CIE Automotive's net debt is only 0.96 times its EBITDA. And its EBIT easily covers its interest expense, being 26.6 times the size. So we're pretty relaxed about its super-conservative use of debt. Also positive, Mahindra CIE Automotive grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Mahindra CIE Automotive's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Mahindra CIE Automotive produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Mahindra CIE Automotive's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Taking all this data into account, it seems to us that Mahindra CIE Automotive takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Mahindra CIE Automotive you should know about.

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.