We Think Bharat Heavy Electricals (NSE:BHEL) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Bharat Heavy Electricals Limited (NSE:BHEL) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Bharat Heavy Electricals

How Much Debt Does Bharat Heavy Electricals Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Bharat Heavy Electricals had debt of ₹57.5b, up from ₹49.9b in one year. However, its balance sheet shows it holds ₹67.2b in cash, so it actually has ₹9.68b net cash.

How Healthy Is Bharat Heavy Electricals' Balance Sheet?

The latest balance sheet data shows that Bharat Heavy Electricals had liabilities of ₹220.1b due within a year, and liabilities of ₹85.0b falling due after that. Offsetting these obligations, it had cash of ₹67.2b as well as receivables valued at ₹32.7b due within 12 months. So its liabilities total ₹205.3b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₹260.9b, so it does suggest shareholders should keep an eye on Bharat Heavy Electricals' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Bharat Heavy Electricals also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Bharat Heavy Electricals made a loss at the EBIT level, last year, it was also good to see that it generated ₹5.4b in EBIT over 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 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

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 ₹9.68b. So although we see some areas for improvement, we're not too worried about Bharat Heavy Electricals's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Bharat Heavy Electricals has 1 warning sign we think you should be aware of.

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.