Bajaj Electricals (NSE:BAJAJELEC) Seems To Use Debt Quite Sensibly

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. Importantly, Bajaj Electricals Limited (NSE:BAJAJELEC) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Bajaj Electricals

How Much Debt Does Bajaj Electricals Carry?

As you can see below, at the end of September 2024, Bajaj Electricals had ₹14.0b of debt, up from ₹6.40b a year ago. Click the image for more detail. However, it does have ₹722.3m in cash offsetting this, leading to net debt of about ₹13.3b.

How Strong Is Bajaj Electricals' Balance Sheet?

According to the last reported balance sheet, Bajaj Electricals had liabilities of ₹21.6b due within 12 months, and liabilities of ₹2.41b due beyond 12 months. Offsetting this, it had ₹722.3m in cash and ₹11.1b in receivables that were due within 12 months. So its liabilities total ₹12.2b more than the combination of its cash and short-term receivables.

Since publicly traded Bajaj Electricals shares are worth a total of ₹84.3b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Bajaj Electricals has a sky high EBITDA ratio of 7.1, implying high debt, but a strong interest coverage of 12.6. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Shareholders should be aware that Bajaj Electricals's EBIT was down 48% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Bajaj Electricals'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Bajaj Electricals actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Bajaj Electricals's EBIT growth rate was a real negative on this analysis, as was its net debt to EBITDA. But its interest cover was significantly redeeming. When we consider all the factors mentioned above, we do feel a bit cautious about Bajaj Electricals's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Bajaj Electricals you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.