These 4 Measures Indicate That Cummins India (NSE:CUMMINSIND) 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 Cummins India Limited (NSE:CUMMINSIND) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Cummins India

What Is Cummins India's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Cummins India had debt of ₹4.93b, up from ₹3.34b in one year. However, its balance sheet shows it holds ₹15.1b in cash, so it actually has ₹10.1b net cash.

How Healthy Is Cummins India's Balance Sheet?

The latest balance sheet data shows that Cummins India had liabilities of ₹15.7b due within a year, and liabilities of ₹1.93b falling due after that. Offsetting these obligations, it had cash of ₹15.1b as well as receivables valued at ₹11.6b due within 12 months. So it can boast ₹9.06b more liquid assets than total liabilities.

This short term liquidity is a sign that Cummins India could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Cummins India has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Cummins India if management cannot prevent a repeat of the 27% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Cummins India's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Looking at the most recent three years, Cummins India recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Cummins India has ₹10.1b in net cash and a decent-looking balance sheet. So we don't have any problem with Cummins India's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Cummins India (1 is significant!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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