Is Voltas (NSE:VOLTAS) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Voltas Limited (NSE:VOLTAS) 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Voltas

What Is Voltas's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Voltas had debt of ₹5.23b, up from ₹3.67b in one year. But on the other hand it also has ₹14.2b in cash, leading to a ₹8.96b net cash position.

How Strong Is Voltas' Balance Sheet?

The latest balance sheet data shows that Voltas had liabilities of ₹40.7b due within a year, and liabilities of ₹1.80b falling due after that. Offsetting these obligations, it had cash of ₹14.2b as well as receivables valued at ₹26.2b due within 12 months. So it has liabilities totalling ₹2.13b more than its cash and near-term receivables, combined.

Having regard to Voltas' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹361.6b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Voltas also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Voltas if management cannot prevent a repeat of the 22% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Voltas'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, a company can only pay off debt with cold hard cash, not accounting profits. Voltas 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. During the last three years, Voltas produced sturdy free cash flow equating to 80% 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 it is always sensible to look at a company's total liabilities, it is very reassuring that Voltas has ₹8.96b in net cash. And it impressed us with free cash flow of ₹6.3b, being 80% of its EBIT. So we don't have any problem with Voltas's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Voltas 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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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.