Amara Raja Energy & Mobility (NSE:ARE&M) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Amara Raja Energy & Mobility Limited (NSE:ARE&M) makes use of debt. But is this debt a concern to shareholders?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Amara Raja Energy & Mobility

What Is Amara Raja Energy & Mobility's Net Debt?

As you can see below, Amara Raja Energy & Mobility had ₹533.3m of debt at March 2024, down from ₹1.11b a year prior. But on the other hand it also has ₹4.56b in cash, leading to a ₹4.03b net cash position.

How Healthy Is Amara Raja Energy & Mobility's Balance Sheet?

We can see from the most recent balance sheet that Amara Raja Energy & Mobility had liabilities of ₹17.3b falling due within a year, and liabilities of ₹4.54b due beyond that. Offsetting this, it had ₹4.56b in cash and ₹12.4b in receivables that were due within 12 months. So it has liabilities totalling ₹4.82b more than its cash and near-term receivables, combined.

Having regard to Amara Raja Energy & Mobility's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹302.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Amara Raja Energy & Mobility also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Amara Raja Energy & Mobility grew its EBIT at 18% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Amara Raja Energy & Mobility 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Amara Raja Energy & Mobility 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, Amara Raja Energy & Mobility's free cash flow amounted to 25% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Amara Raja Energy & Mobility's liabilities, but we can be reassured by the fact it has has net cash of ₹4.03b. And it impressed us with its EBIT growth of 18% over the last year. So we don't have any problem with Amara Raja Energy & Mobility's use of debt. 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. Case in point: We've spotted 3 warning signs for Amara Raja Energy & Mobility you should be aware of, and 1 of them is a bit concerning.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

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