We Think Thermax (NSE:THERMAX) Can Manage Its Debt With Ease

Simply Wall St
December 25, 2021
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Thermax Limited (NSE:THERMAX) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Thermax

How Much Debt Does Thermax Carry?

As you can see below, at the end of September 2021, Thermax had ₹2.99b of debt, up from ₹2.45b a year ago. Click the image for more detail. But it also has ₹18.1b in cash to offset that, meaning it has ₹15.1b net cash.

NSEI:THERMAX Debt to Equity History December 25th 2021

How Healthy Is Thermax's Balance Sheet?

We can see from the most recent balance sheet that Thermax had liabilities of ₹31.6b falling due within a year, and liabilities of ₹1.78b due beyond that. Offsetting these obligations, it had cash of ₹18.1b as well as receivables valued at ₹10.3b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹5.05b.

Given Thermax has a market capitalization of ₹197.5b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Thermax also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Thermax grew its EBIT by 187% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Thermax has ₹15.1b in net cash. The cherry on top was that in converted 120% of that EBIT to free cash flow, bringing in ₹4.9b. So we don't think Thermax's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Thermax's earnings per share history for free.

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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