Hindustan Unilever (NSE:HINDUNILVR) Could Easily Take On More 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 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 Hindustan Unilever Limited (NSE:HINDUNILVR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Hindustan Unilever

What Is Hindustan Unilever's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Hindustan Unilever had debt of ₹11.3b, up from ₹1.87b in one year. However, it does have ₹68.1b in cash offsetting this, leading to net cash of ₹56.8b.

How Healthy Is Hindustan Unilever's Balance Sheet?

According to the last reported balance sheet, Hindustan Unilever had liabilities of ₹113.9b due within 12 months, and liabilities of ₹100.0b due beyond 12 months. Offsetting this, it had ₹68.1b in cash and ₹22.4b in receivables that were due within 12 months. So it has liabilities totalling ₹123.4b more than its cash and near-term receivables, combined.

Of course, Hindustan Unilever has a titanic market capitalization of ₹5.39t, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Hindustan Unilever also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Hindustan Unilever grew its EBIT at 20% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hindustan Unilever's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Hindustan Unilever 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, Hindustan Unilever recorded free cash flow worth 62% 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 Hindustan Unilever has ₹56.8b in net cash. And we liked the look of last year's 20% year-on-year EBIT growth. So we don't think Hindustan Unilever's use of debt is risky. 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. For example - Hindustan Unilever has 1 warning sign we think 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.