MSTC (NSE:MSTCLTD) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 MSTC Limited (NSE:MSTCLTD) makes use of debt. But is this debt a concern to shareholders?

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. 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, 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for MSTC

What Is MSTC's Debt?

The chart below, which you can click on for greater detail, shows that MSTC had ₹1.45b in debt in September 2023; about the same as the year before. However, it does have ₹13.4b in cash offsetting this, leading to net cash of ₹11.9b.

How Strong Is MSTC's Balance Sheet?

The latest balance sheet data shows that MSTC had liabilities of ₹13.8b due within a year, and liabilities of ₹970.7m falling due after that. Offsetting these obligations, it had cash of ₹13.4b as well as receivables valued at ₹4.59b due within 12 months. So it actually has ₹3.20b more liquid assets than total liabilities.

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

But the other side of the story is that MSTC saw its EBIT decline by 5.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since MSTC 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. MSTC 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. Happily for any shareholders, MSTC actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that MSTC has net cash of ₹11.9b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₹3.0b, being 142% of its EBIT. So is MSTC's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - MSTC has 2 warning signs we think you should be aware of.

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.