Is ITC (NSE:ITC) 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 ITC Limited (NSE:ITC) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for ITC

How Much Debt Does ITC Carry?

As you can see below, ITC had ₹2.69b of debt at September 2021, down from ₹2.91b a year prior. But on the other hand it also has ₹167.9b in cash, leading to a ₹165.2b net cash position.

How Healthy Is ITC's Balance Sheet?

According to the last reported balance sheet, ITC had liabilities of ₹107.9b due within 12 months, and liabilities of ₹23.5b due beyond 12 months. Offsetting these obligations, it had cash of ₹167.9b as well as receivables valued at ₹25.2b due within 12 months. So it can boast ₹61.7b more liquid assets than total liabilities.

This surplus suggests that ITC has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that ITC has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that ITC has been able to increase its EBIT by 22% in twelve months, making it easier to pay down 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 ITC 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While ITC 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, ITC produced sturdy free cash flow equating to 66% 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 ITC has net cash of ₹165.2b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 22% over the last year. So we don't think ITC's use of debt is risky. 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. To that end, you should be aware of the 2 warning signs we've spotted with ITC .

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.