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 note that Venky's (India) Limited (NSE:VENKEYS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Venky's (India)'s Debt?
You can click the graphic below for the historical numbers, but it shows that Venky's (India) had ₹1.97b of debt in September 2021, down from ₹2.62b, one year before. However, it does have ₹2.31b in cash offsetting this, leading to net cash of ₹331.7m.
How Healthy Is Venky's (India)'s Balance Sheet?
The latest balance sheet data shows that Venky's (India) had liabilities of ₹5.08b due within a year, and liabilities of ₹573.7m falling due after that. On the other hand, it had cash of ₹2.31b and ₹4.78b worth of receivables due within a year. So it actually has ₹1.43b more liquid assets than total liabilities.
This surplus suggests that Venky's (India) has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Venky's (India) has more cash than debt is arguably a good indication that it can manage its debt safely.
It was also good to see that despite losing money on the EBIT line last year, Venky's (India) turned things around in the last 12 months, delivering and EBIT of ₹3.5b. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Venky's (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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Venky's (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 year, Venky's (India)'s free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to investigate a company's debt, in this case Venky's (India) has ₹331.7m in net cash and a decent-looking balance sheet. So we are not troubled with Venky's (India)'s debt use. 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. Case in point: We've spotted 1 warning sign for Venky's (India) you should be aware of.
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.
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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.
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