These 4 Measures Indicate That Cochin Shipyard (NSE:COCHINSHIP) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Cochin Shipyard Limited (NSE:COCHINSHIP) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Cochin Shipyard

What Is Cochin Shipyard's Debt?

As you can see below, at the end of March 2023, Cochin Shipyard had ₹1.33b of debt, up from ₹1.23b a year ago. Click the image for more detail. But it also has ₹47.6b in cash to offset that, meaning it has ₹46.3b net cash.

How Strong Is Cochin Shipyard's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cochin Shipyard had liabilities of ₹51.2b due within 12 months and liabilities of ₹4.72b due beyond that. On the other hand, it had cash of ₹47.6b and ₹4.11b worth of receivables due within a year. So its liabilities total ₹4.24b more than the combination of its cash and short-term receivables.

Since publicly traded Cochin Shipyard shares are worth a total of ₹64.1b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Cochin Shipyard also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Cochin Shipyard if management cannot prevent a repeat of the 42% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Cochin Shipyard's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Cochin Shipyard 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. Happily for any shareholders, Cochin Shipyard actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Cochin Shipyard has ₹46.3b in net cash. And it impressed us with free cash flow of ₹16b, being 164% of its EBIT. So we don't have any problem with Cochin Shipyard's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Cochin Shipyard that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.