Thejo Engineering (NSE:THEJO) Seems To Use Debt Quite Sensibly

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, Thejo Engineering Limited (NSE:THEJO) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Thejo Engineering

How Much Debt Does Thejo Engineering Carry?

You can click the graphic below for the historical numbers, but it shows that Thejo Engineering had ₹203.9m of debt in September 2020, down from ₹302.7m, one year before. But on the other hand it also has ₹249.8m in cash, leading to a ₹45.9m net cash position.

How Healthy Is Thejo Engineering's Balance Sheet?

We can see from the most recent balance sheet that Thejo Engineering had liabilities of ₹794.5m falling due within a year, and liabilities of ₹141.8m due beyond that. Offsetting this, it had ₹249.8m in cash and ₹1.18b in receivables that were due within 12 months. So it actually has ₹498.4m more liquid assets than total liabilities.

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

But the other side of the story is that Thejo Engineering saw its EBIT decline by 4.0% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Thejo Engineering 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. While Thejo Engineering 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. Over the most recent three years, Thejo Engineering recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Thejo Engineering has ₹45.9m in net cash and a decent-looking balance sheet. So we are not troubled with Thejo Engineering'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. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Thejo Engineering you should know about.

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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