Does Amara Raja Energy & Mobility (NSE:ARE&M) Have A Healthy Balance Sheet?

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.' 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. We can see that Amara Raja Energy & Mobility Limited (NSE:ARE&M) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See 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 ₹1.08b of debt at September 2023, down from ₹1.22b a year prior. However, it does have ₹5.75b in cash offsetting this, leading to net cash of ₹4.67b.

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

Zooming in on the latest balance sheet data, we can see that Amara Raja Energy & Mobility had liabilities of ₹18.2b due within 12 months and liabilities of ₹3.80b due beyond that. On the other hand, it had cash of ₹5.75b and ₹12.1b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹4.15b.

Of course, Amara Raja Energy & Mobility has a market capitalization of ₹155.0b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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.

In addition to that, we're happy to report that Amara Raja Energy & Mobility has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. 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. Amara Raja Energy & Mobility 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. Looking at the most recent three years, Amara Raja Energy & Mobility recorded free cash flow of 23% of its EBIT, which is weaker 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 ₹4.67b. And we liked the look of last year's 30% year-on-year EBIT growth. So we don't think Amara Raja Energy & Mobility's use of debt is 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. Be aware that Amara Raja Energy & Mobility is showing 2 warning signs in our investment analysis , you should know about...

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.