Is Emami (NSE:EMAMILTD) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Emami Limited (NSE:EMAMILTD) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Emami

How Much Debt Does Emami Carry?

As you can see below, Emami had ₹772.6m of debt at March 2021, down from ₹2.10b a year prior. However, its balance sheet shows it holds ₹4.86b in cash, so it actually has ₹4.08b net cash.

A Look At Emami's Liabilities

The latest balance sheet data shows that Emami had liabilities of ₹7.00b due within a year, and liabilities of ₹577.5m falling due after that. Offsetting these obligations, it had cash of ₹4.86b as well as receivables valued at ₹2.35b due within 12 months. So its liabilities total ₹376.1m more than the combination of its cash and short-term receivables.

Having regard to Emami's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹239.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Emami also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Emami grew its EBIT by 41% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Emami can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Emami 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 last three years, Emami actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about Emami's liabilities, but we can be reassured by the fact it has has net cash of ₹4.08b. The cherry on top was that in converted 130% of that EBIT to free cash flow, bringing in ₹8.9b. So we don't think Emami's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Emami 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. 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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