Here's Why Bajaj Electricals (NSE:BAJAJELEC) Can Manage Its Debt Responsibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Bajaj Electricals Limited (NSE:BAJAJELEC) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Bajaj Electricals

What Is Bajaj Electricals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Bajaj Electricals had ₹6.81b of debt, an increase on ₹3.95b, over one year. On the flip side, it has ₹4.09b in cash leading to net debt of about ₹2.72b.

A Look At Bajaj Electricals' Liabilities

The latest balance sheet data shows that Bajaj Electricals had liabilities of ₹26.2b due within a year, and liabilities of ₹1.53b falling due after that. Offsetting these obligations, it had cash of ₹4.09b as well as receivables valued at ₹17.0b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹6.61b.

Since publicly traded Bajaj Electricals shares are worth a total of ₹130.5b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

While Bajaj Electricals's low debt to EBITDA ratio of 0.83 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 7.0 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. On the other hand, Bajaj Electricals saw its EBIT drop by 5.3% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Bajaj Electricals actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Bajaj Electricals's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its EBIT growth rate does undermine this impression a bit. When we consider the range of factors above, it looks like Bajaj Electricals is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Bajaj Electricals is showing 2 warning signs in our investment analysis , you should know about...

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.