Stock Analysis

Is Cummins India (NSE:CUMMINSIND) Using Too Much Debt?

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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Cummins India Limited (NSE:CUMMINSIND) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Cummins India

How Much Debt Does Cummins India Carry?

As you can see below, at the end of September 2022, Cummins India had ₹2.65b of debt, up from ₹509.9m a year ago. Click the image for more detail. However, it does have ₹20.5b in cash offsetting this, leading to net cash of ₹17.8b.

NSEI:CUMMINSIND Debt to Equity History March 15th 2023

A Look At Cummins India's Liabilities

The latest balance sheet data shows that Cummins India had liabilities of ₹17.5b due within a year, and liabilities of ₹2.79b falling due after that. On the other hand, it had cash of ₹20.5b and ₹14.2b worth of receivables due within a year. So it can boast ₹14.4b more liquid assets than total liabilities.

This surplus suggests that Cummins India has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Cummins India has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Cummins India grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Cummins India'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 Cummins India 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, Cummins India produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Cummins India has net cash of ₹17.8b, as well as more liquid assets than liabilities. And we liked the look of last year's 34% year-on-year EBIT growth. So we don't think Cummins India's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Cummins India you should know about.

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.