Here's Why SKF India (NSE:SKFINDIA) 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. As with many other companies SKF India Limited (NSE:SKFINDIA) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for SKF India

What Is SKF India's Debt?

As you can see below, SKF India had ₹300.0m of debt at September 2020, down from ₹1.16b a year prior. However, it does have ₹3.22b in cash offsetting this, leading to net cash of ₹2.92b.

How Healthy Is SKF India's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SKF India had liabilities of ₹5.02b due within 12 months and liabilities of ₹474.3m due beyond that. Offsetting this, it had ₹3.22b in cash and ₹5.00b in receivables that were due within 12 months. So it actually has ₹2.73b more liquid assets than total liabilities.

This surplus suggests that SKF India has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, SKF India boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, SKF India's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is SKF India's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While SKF India 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. Looking at the most recent three years, SKF India recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that SKF India has net cash of ₹2.92b, as well as more liquid assets than liabilities. So we are not troubled with SKF India's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that SKF India 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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This article by Simply Wall St is general in nature. 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.
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