Is Elecon Engineering (NSE:ELECON) Using Too Much Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Elecon Engineering Company Limited (NSE:ELECON) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Elecon Engineering

How Much Debt Does Elecon Engineering Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Elecon Engineering had ₹1.18b of debt, an increase on ₹454.8m, over one year. But it also has ₹5.32b in cash to offset that, meaning it has ₹4.14b net cash.

How Healthy Is Elecon Engineering's Balance Sheet?

The latest balance sheet data shows that Elecon Engineering had liabilities of ₹4.38b due within a year, and liabilities of ₹1.55b falling due after that. Offsetting these obligations, it had cash of ₹5.32b as well as receivables valued at ₹4.84b due within 12 months. So it actually has ₹4.23b more liquid assets than total liabilities.

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

And we also note warmly that Elecon Engineering grew its EBIT by 13% last year, making its debt load easier to handle. 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 Elecon Engineering'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Elecon Engineering 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, Elecon Engineering produced sturdy free cash flow equating to 74% 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 it is always sensible to investigate a company's debt, in this case Elecon Engineering has ₹4.14b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹2.7b, being 74% of its EBIT. So is Elecon Engineering's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for Elecon Engineering that you should be aware of.

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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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.