Nestlé India (NSE:NESTLEIND) Could Easily Take On More Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Nestlé India Limited (NSE:NESTLEIND) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Nestlé India

What Is Nestlé India's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Nestlé India had ₹562.2m of debt, an increase on ₹515.2m, over one year. But it also has ₹29.6b in cash to offset that, meaning it has ₹29.1b net cash.

How Healthy Is Nestlé India's Balance Sheet?

The latest balance sheet data shows that Nestlé India had liabilities of ₹25.8b due within a year, and liabilities of ₹32.5b falling due after that. On the other hand, it had cash of ₹29.6b and ₹2.22b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹26.5b.

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 ₹1.77t 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.

Fortunately, Nestlé India grew its EBIT by 9.6% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nestlé India's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 75% 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 ₹29.1b in net cash. And it impressed us with free cash flow of ₹17b, being 75% of its EBIT. So we don't think Nestlé India's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Nestlé India you should be aware of.

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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