These 4 Measures Indicate That Bharat Heavy Electricals (NSE:BHEL) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Bharat Heavy Electricals Limited (NSE:BHEL) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Net Debt?

As you can see below, at the end of September 2022, Bharat Heavy Electricals had ₹56.8b of debt, up from ₹49.0b a year ago. Click the image for more detail. But on the other hand it also has ₹67.2b in cash, leading to a ₹10.4b net cash position.

How Healthy Is Bharat Heavy Electricals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Bharat Heavy Electricals had liabilities of ₹220.1b due within 12 months and liabilities of ₹85.0b due beyond that. Offsetting this, it had ₹67.2b in cash and ₹34.6b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹203.4b.

This is a mountain of leverage relative to its market capitalization of ₹259.1b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Bharat Heavy Electricals boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Bharat Heavy Electricals turned things around in the last 12 months, delivering and EBIT of ₹6.1b. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While Bharat Heavy Electricals does have more liabilities than liquid assets, it also has net cash of ₹10.4b. 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. Be aware that Bharat Heavy Electricals is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.