Does SML Isuzu (NSE:SMLISUZU) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, SML Isuzu Limited (NSE:SMLISUZU) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for SML Isuzu

What Is SML Isuzu's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 SML Isuzu had ₹2.91b of debt, an increase on ₹2.55b, over one year. On the flip side, it has ₹446.7m in cash leading to net debt of about ₹2.46b.

How Strong Is SML Isuzu's Balance Sheet?

The latest balance sheet data shows that SML Isuzu had liabilities of ₹5.95b due within a year, and liabilities of ₹1.09b falling due after that. Offsetting these obligations, it had cash of ₹446.7m as well as receivables valued at ₹1.34b due within 12 months. So its liabilities total ₹5.25b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because SML Isuzu is worth ₹17.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While SML Isuzu's low debt to EBITDA ratio of 1.1 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.1 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. On top of that, SML Isuzu grew its EBIT by 59% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is SML Isuzu'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, SML Isuzu barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

On our analysis SML Isuzu's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. In particular, conversion of EBIT to free cash flow gives us cold feet. When we consider all the elements mentioned above, it seems to us that SML Isuzu is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example, we've discovered 2 warning signs for SML Isuzu that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.