Thermax (NSE:THERMAX) Could Easily Take On More Debt

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. We can see that Thermax Limited (NSE:THERMAX) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Thermax

What Is Thermax's Net Debt?

As you can see below, at the end of September 2022, Thermax had ₹4.65b of debt, up from ₹2.99b a year ago. Click the image for more detail. But on the other hand it also has ₹22.8b in cash, leading to a ₹18.1b net cash position.

How Healthy Is Thermax's Balance Sheet?

The latest balance sheet data shows that Thermax had liabilities of ₹40.4b due within a year, and liabilities of ₹2.46b falling due after that. On the other hand, it had cash of ₹22.8b and ₹16.6b worth of receivables due within a year. So it has liabilities totalling ₹3.51b more than its cash and near-term receivables, combined.

Having regard to Thermax's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹221.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Thermax boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Thermax has increased its EBIT by 3.4% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Thermax can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Thermax 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, Thermax actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Thermax has ₹18.1b in net cash. And it impressed us with free cash flow of ₹937m, being 140% of its EBIT. So we don't think Thermax's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Thermax .

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.