Is Elgi Equipments (NSE:ELGIEQUIP) Using Too Much Debt?

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 Elgi Equipments Limited (NSE:ELGIEQUIP) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Elgi Equipments

What Is Elgi Equipments's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Elgi Equipments had ₹5.60b of debt, an increase on ₹5.09b, over one year. But on the other hand it also has ₹7.74b in cash, leading to a ₹2.14b net cash position.

How Healthy Is Elgi Equipments' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Elgi Equipments had liabilities of ₹11.0b due within 12 months and liabilities of ₹1.06b due beyond that. Offsetting these obligations, it had cash of ₹7.74b as well as receivables valued at ₹6.08b due within 12 months. So it can boast ₹1.73b more liquid assets than total liabilities.

Having regard to Elgi Equipments' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹194.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Elgi Equipments has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Elgi Equipments has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Elgi Equipments can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Elgi Equipments may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Elgi Equipments 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 Elgi Equipments has ₹2.14b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 29% over the last year. So we don't think Elgi Equipments's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Elgi Equipments's earnings per share history for free.

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.