These 4 Measures Indicate That Munjal Auto Industries (NSE:MUNJALAU) Is Using Debt Reasonably Well

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Munjal Auto Industries Limited (NSE:MUNJALAU) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Munjal Auto Industries

How Much Debt Does Munjal Auto Industries Carry?

You can click the graphic below for the historical numbers, but it shows that Munjal Auto Industries had ₹821.1m of debt in March 2021, down from ₹1.23b, one year before. On the flip side, it has ₹443.9m in cash leading to net debt of about ₹377.2m.

How Healthy Is Munjal Auto Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Munjal Auto Industries had liabilities of ₹4.53b due within 12 months and liabilities of ₹1.21b due beyond that. Offsetting this, it had ₹443.9m in cash and ₹4.18b in receivables that were due within 12 months. So its liabilities total ₹1.11b more than the combination of its cash and short-term receivables.

Since publicly traded Munjal Auto Industries shares are worth a total of ₹6.84b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Munjal Auto Industries's low debt to EBITDA ratio of 0.45 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.8 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, Munjal Auto Industries is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 218% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Munjal Auto Industries will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Munjal Auto Industries burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Munjal Auto Industries is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its EBIT growth rate. Looking at all this data makes us feel a little cautious about Munjal Auto Industries's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. We've identified 3 warning signs with Munjal Auto Industries (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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