Here's Why HEG (NSE:HEG) Can Manage Its Debt Responsibly

Warren Buffett famously said, '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. We note that HEG Limited (NSE:HEG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 HEG

How Much Debt Does HEG Carry?

The image below, which you can click on for greater detail, shows that at March 2022 HEG had debt of ₹6.63b, up from ₹2.97b in one year. However, it does have ₹12.7b in cash offsetting this, leading to net cash of ₹6.07b.

A Look At HEG's Liabilities

According to the last reported balance sheet, HEG had liabilities of ₹12.9b due within 12 months, and liabilities of ₹1.07b due beyond 12 months. Offsetting this, it had ₹12.7b in cash and ₹5.90b in receivables that were due within 12 months. So it actually has ₹4.66b more liquid assets than total liabilities.

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

Although HEG made a loss at the EBIT level, last year, it was also good to see that it generated ₹4.5b in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is HEG's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. HEG 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. During the last year, HEG burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case HEG has ₹6.07b in net cash and a decent-looking balance sheet. So we are not troubled with HEG's debt use. 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. We've identified 3 warning signs with HEG (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.