Is Voltas (NSE:VOLTAS) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Voltas Limited (NSE:VOLTAS) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Net Debt?

The chart below, which you can click on for greater detail, shows that Voltas had ₹4.27b in debt in September 2021; about the same as the year before. But it also has ₹7.01b in cash to offset that, meaning it has ₹2.74b net cash.

How Strong Is Voltas' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Voltas had liabilities of ₹29.2b due within 12 months and liabilities of ₹1.31b due beyond that. Offsetting this, it had ₹7.01b in cash and ₹26.1b in receivables that were due within 12 months. So it actually has ₹2.57b more liquid assets than total liabilities.

This state of affairs indicates that Voltas' 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 ₹388.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Voltas has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Voltas has boosted its EBIT by 50%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Voltas can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Voltas 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, Voltas produced sturdy free cash flow equating to 64% 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 Voltas has net cash of ₹2.74b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 50% over the last year. So is Voltas's debt a risk? It doesn't seem so to us. 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 Voltas's earnings per share history for free.

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. 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.