Is Greaves Cotton (NSE:GREAVESCOT) Using Debt In A Risky Way?

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. Importantly, Greaves Cotton Limited (NSE:GREAVESCOT) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Greaves Cotton

What Is Greaves Cotton's Net Debt?

As you can see below, at the end of March 2022, Greaves Cotton had ₹2.33b of debt, up from ₹35.7m a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹4.42b in cash, so it actually has ₹2.09b net cash.

How Strong Is Greaves Cotton's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Greaves Cotton had liabilities of ₹6.77b due within 12 months and liabilities of ₹2.18b due beyond that. Offsetting this, it had ₹4.42b in cash and ₹1.86b in receivables that were due within 12 months. So it has liabilities totalling ₹2.66b more than its cash and near-term receivables, combined.

Of course, Greaves Cotton has a market capitalization of ₹37.4b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Greaves Cotton also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Greaves Cotton will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Greaves Cotton reported revenue of ₹17b, which is a gain of 14%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is Greaves Cotton?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Greaves Cotton had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of ₹1.3b and booked a ₹353m accounting loss. Given it only has net cash of ₹2.09b, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. We've identified 2 warning signs with Greaves Cotton (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.