Here's Why Coal India (NSE:COALINDIA) 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.' 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 Coal India Limited (NSE:COALINDIA) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Coal India

What Is Coal India's Debt?

The image below, which you can click on for greater detail, shows that Coal India had debt of ₹33.5b at the end of September 2021, a reduction from ₹48.1b over a year. However, its balance sheet shows it holds ₹283.4b in cash, so it actually has ₹249.8b net cash.

How Healthy Is Coal India's Balance Sheet?

The latest balance sheet data shows that Coal India had liabilities of ₹498.9b due within a year, and liabilities of ₹748.4b falling due after that. Offsetting this, it had ₹283.4b in cash and ₹248.3b in receivables that were due within 12 months. So its liabilities total ₹715.7b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of ₹1.13t, so it does suggest shareholders should keep an eye on Coal India's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Coal India boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Coal India grew its EBIT at 17% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Coal India 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Coal India 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. In the last three years, Coal India's free cash flow amounted to 29% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Coal India's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹249.8b. And we liked the look of last year's 17% year-on-year EBIT growth. So we don't have any problem with Coal India's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Coal India you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.