Is Timken India (NSE:TIMKEN) A Risky Investment?

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.' 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. We can see that Timken India Limited (NSE:TIMKEN) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Timken India

What Is Timken India's Net Debt?

As you can see below, at the end of March 2021, Timken India had ₹326.9m of debt, up from ₹199.6m a year ago. Click the image for more detail. But on the other hand it also has ₹1.76b in cash, leading to a ₹1.44b net cash position.

How Healthy Is Timken India's Balance Sheet?

According to the last reported balance sheet, Timken India had liabilities of ₹4.37b due within 12 months, and liabilities of ₹1.08b due beyond 12 months. On the other hand, it had cash of ₹1.76b and ₹3.73b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Timken India's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹110.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Timken India has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Timken India's load is not too heavy, because its EBIT was down 39% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Timken India will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Timken India 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. During the last three years, Timken India produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Timken India has net cash of ₹1.44b, as well as more liquid assets than liabilities. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in ₹1.1b. So we don't have any problem with Timken India's use of debt. 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. We've identified 1 warning sign with Timken India , and understanding them should be part of your investment process.

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. 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.
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