Is Bharat Heavy Electricals (NSE:BHEL) Using Too Much 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 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. We note that Bharat Heavy Electricals Limited (NSE:BHEL) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. 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 Bharat Heavy Electricals

What Is Bharat Heavy Electricals's Debt?

As you can see below, Bharat Heavy Electricals had ₹47.5b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds ₹71.5b in cash, so it actually has ₹24.1b net cash.

A Look At Bharat Heavy Electricals' Liabilities

According to the last reported balance sheet, Bharat Heavy Electricals had liabilities of ₹213.7b due within 12 months, and liabilities of ₹83.7b due beyond 12 months. Offsetting this, it had ₹71.5b in cash and ₹30.2b in receivables that were due within 12 months. So it has liabilities totalling ₹195.6b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₹178.3b, we think shareholders really should watch Bharat Heavy Electricals's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Given that Bharat Heavy Electricals has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Notably, Bharat Heavy Electricals made a loss at the EBIT level, last year, but improved that to positive EBIT of ₹4.2b in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Bharat Heavy Electricals can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Bharat Heavy Electricals 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 year, Bharat Heavy Electricals actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Bharat Heavy Electricals's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹24.1b. The cherry on top was that in converted 116% of that EBIT to free cash flow, bringing in ₹4.9b. So although we see some areas for improvement, we're not too worried about Bharat Heavy Electricals's balance sheet. 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. We've identified 1 warning sign with Bharat Heavy Electricals , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.