Precision Camshafts (NSE:PRECAM) Could Easily Take On More Debt

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Precision Camshafts Limited (NSE:PRECAM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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

See our latest analysis for Precision Camshafts

What Is Precision Camshafts's Debt?

As you can see below, Precision Camshafts had ₹821.3m of debt at September 2024, down from ₹1.01b a year prior. However, it does have ₹3.61b in cash offsetting this, leading to net cash of ₹2.79b.

How Healthy Is Precision Camshafts' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Precision Camshafts had liabilities of ₹2.21b due within 12 months and liabilities of ₹417.6m due beyond that. Offsetting these obligations, it had cash of ₹3.61b as well as receivables valued at ₹1.58b due within 12 months. So it can boast ₹2.57b more liquid assets than total liabilities.

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

If Precision Camshafts can keep growing EBIT at last year's rate of 10% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Precision Camshafts 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Precision Camshafts 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, Precision Camshafts actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Precision Camshafts has net cash of ₹2.79b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₹846m, being 149% of its EBIT. So we don't think Precision Camshafts'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. To that end, you should learn about the 2 warning signs we've spotted with Precision Camshafts (including 1 which can't be ignored) .

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.