Blue Star (NSE:BLUESTARCO) Seems To Use Debt Quite Sensibly

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.' 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, Blue Star Limited (NSE:BLUESTARCO) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Blue Star

How Much Debt Does Blue Star Carry?

As you can see below, at the end of September 2023, Blue Star had ₹8.70b of debt, up from ₹7.96b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹10.8b in cash, so it actually has ₹2.10b net cash.

How Healthy Is Blue Star's Balance Sheet?

We can see from the most recent balance sheet that Blue Star had liabilities of ₹34.3b falling due within a year, and liabilities of ₹2.67b due beyond that. Offsetting these obligations, it had cash of ₹10.8b as well as receivables valued at ₹12.5b due within 12 months. So it has liabilities totalling ₹13.7b more than its cash and near-term receivables, combined.

Given Blue Star has a market capitalization of ₹270.8b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Blue Star also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Blue Star grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Blue Star's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Blue Star 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. During the last three years, Blue Star burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

We could understand if investors are concerned about Blue Star's liabilities, but we can be reassured by the fact it has has net cash of ₹2.10b. And we liked the look of last year's 33% year-on-year EBIT growth. So we don't have any problem with Blue Star's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Blue Star , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.