MRF (NSE:MRF) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, MRF Limited (NSE:MRF) 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. 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.

See our latest analysis for MRF

What Is MRF's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 MRF had debt of ₹22.3b, up from ₹19.5b in one year. But it also has ₹36.6b in cash to offset that, meaning it has ₹14.4b net cash.

A Look At MRF's Liabilities

We can see from the most recent balance sheet that MRF had liabilities of ₹70.8b falling due within a year, and liabilities of ₹21.6b due beyond that. On the other hand, it had cash of ₹36.6b and ₹23.8b worth of receivables due within a year. So its liabilities total ₹32.0b more than the combination of its cash and short-term receivables.

Since publicly traded MRF shares are worth a total of ₹313.6b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, MRF also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that MRF grew its EBIT by 19% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if MRF 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. MRF 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. In the last three years, MRF created free cash flow amounting to 18% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

Although MRF's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹14.4b. And we liked the look of last year's 19% year-on-year EBIT growth. So we don't have any problem with MRF's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in MRF, you may well want to click here to check an interactive graph of its earnings per share history.

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.