Kajaria Ceramics (NSE:KAJARIACER) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Kajaria Ceramics Limited (NSE:KAJARIACER) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Kajaria Ceramics

How Much Debt Does Kajaria Ceramics Carry?

You can click the graphic below for the historical numbers, but it shows that Kajaria Ceramics had ₹690.9m of debt in September 2020, down from ₹1.05b, one year before. But it also has ₹4.28b in cash to offset that, meaning it has ₹3.59b net cash.

How Strong Is Kajaria Ceramics's Balance Sheet?

We can see from the most recent balance sheet that Kajaria Ceramics had liabilities of ₹3.91b falling due within a year, and liabilities of ₹1.44b due beyond that. Offsetting this, it had ₹4.28b in cash and ₹3.37b in receivables that were due within 12 months. So it actually has ₹2.29b more liquid assets than total liabilities.

This short term liquidity is a sign that Kajaria Ceramics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Kajaria Ceramics boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Kajaria Ceramics if management cannot prevent a repeat of the 36% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Kajaria Ceramics's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Kajaria Ceramics 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, Kajaria Ceramics produced sturdy free cash flow equating to 60% 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 we empathize with investors who find debt concerning, you should keep in mind that Kajaria Ceramics has net cash of ₹3.59b, as well as more liquid assets than liabilities. So we don't have any problem with Kajaria Ceramics'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. Be aware that Kajaria Ceramics is showing 1 warning sign in our investment analysis , you should know about...

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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