Is Nestlé India (NSE:NESTLEIND) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, Nestlé India Limited (NSE:NESTLEIND) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Nestlé India

How Much Debt Does Nestlé India Carry?

As you can see below, Nestlé India had ₹348.4m of debt at December 2020, down from ₹532.3m a year prior. But on the other hand it also has ₹25.5b in cash, leading to a ₹25.2b net cash position.

How Healthy Is Nestlé India's Balance Sheet?

We can see from the most recent balance sheet that Nestlé India had liabilities of ₹24.9b falling due within a year, and liabilities of ₹33.9b due beyond that. Offsetting this, it had ₹25.5b in cash and ₹1.78b in receivables that were due within 12 months. So its liabilities total ₹31.5b more than the combination of its cash and short-term receivables.

Having regard to Nestlé India's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹1.59t company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Nestlé India also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Nestlé India grew its EBIT by 16% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nestlé India will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Nestlé India may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Nestlé India recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Nestlé India has ₹25.2b in net cash. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in ₹20b. So is Nestlé India's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. 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 Nestlé India you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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