Is Timken India (NSE:TIMKEN) Using Too Much Debt?

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

Why Does Debt Bring Risk?

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. 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.

See our latest analysis for Timken India

What Is Timken India's Debt?

The chart below, which you can click on for greater detail, shows that Timken India had ₹294.4m in debt in March 2023; about the same as the year before. But it also has ₹3.98b in cash to offset that, meaning it has ₹3.68b net cash.

How Strong Is Timken India's Balance Sheet?

According to the last reported balance sheet, Timken India had liabilities of ₹4.27b due within 12 months, and liabilities of ₹920.4m due beyond 12 months. Offsetting this, it had ₹3.98b in cash and ₹5.80b in receivables that were due within 12 months. So it actually has ₹4.58b more liquid assets than 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 ₹243.1b 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.

Also positive, Timken India grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Timken India's earnings that will influence how the balance sheet holds up in the future. 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 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. Looking at the most recent three years, Timken India recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Timken India has ₹3.68b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 23% over the last year. So we don't think Timken India's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Timken India, you may well want to click here to check an interactive graph of its earnings per share history.

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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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.