Nestlé India (NSE:NESTLEIND) Seems To Use Debt Rather Sparingly

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.' 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. We note that Nestlé India Limited (NSE:NESTLEIND) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Nestlé India

What Is Nestlé India's Debt?

The image below, which you can click on for greater detail, shows that Nestlé India had debt of ₹1.51b at the end of June 2021, a reduction from ₹1.90b over a year. However, its balance sheet shows it holds ₹21.8b in cash, so it actually has ₹20.2b net cash.

How Healthy Is Nestlé India's Balance Sheet?

The latest balance sheet data shows that Nestlé India had liabilities of ₹23.2b due within a year, and liabilities of ₹35.3b falling due after that. Offsetting this, it had ₹21.8b in cash and ₹2.12b in receivables that were due within 12 months. So its liabilities total ₹34.6b more than the combination of its cash and short-term receivables.

This state of affairs indicates that Nestlé India's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹1.85t company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Nestlé India boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Nestlé India grew its EBIT by 11% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Nestlé India's earnings that will influence how the balance sheet holds up in the future. 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. While Nestlé 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. During the last three years, Nestlé India produced sturdy free cash flow equating to 72% 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 it is always sensible to look at a company's total liabilities, it is very reassuring that Nestlé India has ₹20.2b in net cash. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in ₹19b. So is Nestlé India's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for Nestlé India that you should be aware of before investing here.

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.

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.

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