Is Crompton Greaves Consumer Electricals (NSE:CROMPTON) A Risky Investment?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Crompton Greaves Consumer Electricals Limited (NSE:CROMPTON) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 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 Crompton Greaves Consumer Electricals

What Is Crompton Greaves Consumer Electricals's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Crompton Greaves Consumer Electricals had ₹16.1b of debt, an increase on ₹4.79b, over one year. On the flip side, it has ₹15.4b in cash leading to net debt of about ₹684.9m.

A Look At Crompton Greaves Consumer Electricals' Liabilities

According to the last reported balance sheet, Crompton Greaves Consumer Electricals had liabilities of ₹30.2b due within 12 months, and liabilities of ₹1.98b due beyond 12 months. Offsetting these obligations, it had cash of ₹15.4b as well as receivables valued at ₹6.40b due within 12 months. So its liabilities total ₹10.3b more than the combination of its cash and short-term receivables.

Of course, Crompton Greaves Consumer Electricals has a market capitalization of ₹233.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Crompton Greaves Consumer Electricals has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.089 times EBITDA and EBIT covering interest a whopping 20.6 times, it's clear that Crompton Greaves Consumer Electricals is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. The good news is that Crompton Greaves Consumer Electricals has increased its EBIT by 5.3% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Crompton Greaves Consumer Electricals can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Crompton Greaves Consumer Electricals generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Crompton Greaves Consumer Electricals's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, Crompton Greaves Consumer Electricals seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. We've identified 2 warning signs with Crompton Greaves Consumer Electricals , and understanding them should be part of your investment process.

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.