Here's Why Motherson Sumi Wiring India (NSE:MSUMI) Can Manage Its Debt Responsibly

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 can see that Motherson Sumi Wiring India Limited (NSE:MSUMI) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Motherson Sumi Wiring India

How Much Debt Does Motherson Sumi Wiring India Carry?

The image below, which you can click on for greater detail, shows that Motherson Sumi Wiring India had debt of ₹2.83b at the end of September 2023, a reduction from ₹3.74b over a year. However, it does have ₹164.3m in cash offsetting this, leading to net debt of about ₹2.66b.

How Healthy Is Motherson Sumi Wiring India's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Motherson Sumi Wiring India had liabilities of ₹12.9b due within 12 months and liabilities of ₹2.58b due beyond that. On the other hand, it had cash of ₹164.3m and ₹9.16b worth of receivables due within a year. So it has liabilities totalling ₹6.14b more than its cash and near-term receivables, combined.

This state of affairs indicates that Motherson Sumi Wiring India's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹323.2b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Motherson Sumi Wiring India has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Motherson Sumi Wiring India's net debt is only 0.32 times its EBITDA. And its EBIT easily covers its interest expense, being 46.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Motherson Sumi Wiring India has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Motherson Sumi Wiring India can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Motherson Sumi Wiring India's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Motherson Sumi Wiring India's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Zooming out, Motherson Sumi Wiring India seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Motherson Sumi Wiring India .

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.