We Think Sharda Motor Industries (NSE:SHARDAMOTR) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Sharda Motor Industries Limited (NSE:SHARDAMOTR) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sharda Motor Industries

What Is Sharda Motor Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Sharda Motor Industries had ₹125.4m of debt, an increase on ₹105.6m, over one year. But it also has ₹2.86b in cash to offset that, meaning it has ₹2.74b net cash.

A Look At Sharda Motor Industries' Liabilities

According to the last reported balance sheet, Sharda Motor Industries had liabilities of ₹4.39b due within 12 months, and liabilities of ₹184.0m due beyond 12 months. Offsetting this, it had ₹2.86b in cash and ₹2.85b in receivables that were due within 12 months. So it can boast ₹1.14b more liquid assets than total liabilities.

This short term liquidity is a sign that Sharda Motor Industries could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Sharda Motor Industries has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Sharda Motor Industries grew its EBIT by 170% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Sharda Motor Industries's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sharda Motor Industries has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Sharda Motor Industries created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Sharda Motor Industries has ₹2.74b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 170% over the last year. So is Sharda Motor Industries's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Sharda Motor Industries's earnings per share history for free.

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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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.