Thermax (NSE:THERMAX) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Thermax Limited (NSE:THERMAX) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Thermax

What Is Thermax's Net Debt?

As you can see below, at the end of September 2020, Thermax had ₹2.31b of debt, up from ₹1.66b a year ago. Click the image for more detail. However, it does have ₹21.2b in cash offsetting this, leading to net cash of ₹18.9b.

How Healthy Is Thermax's Balance Sheet?

The latest balance sheet data shows that Thermax had liabilities of ₹27.8b due within a year, and liabilities of ₹1.29b falling due after that. Offsetting this, it had ₹21.2b in cash and ₹11.2b in receivables that were due within 12 months. So it actually has ₹3.27b more liquid assets than total liabilities.

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

In fact Thermax's saving grace is its low debt levels, because its EBIT has tanked 70% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Thermax's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. Over the most recent three years, Thermax recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Thermax has ₹18.9b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in ₹5.8b. So we are not troubled with Thermax's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Thermax has 2 warning signs we think you should be aware of.

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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