Is Ambuja Cements (NSE:AMBUJACEM) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Ambuja Cements Limited (NSE:AMBUJACEM) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Ambuja Cements

What Is Ambuja Cements's Debt?

The chart below, which you can click on for greater detail, shows that Ambuja Cements had ₹468.3m in debt in December 2022; about the same as the year before. But on the other hand it also has ₹98.3b in cash, leading to a ₹97.8b net cash position.

How Healthy Is Ambuja Cements' Balance Sheet?

According to the last reported balance sheet, Ambuja Cements had liabilities of ₹106.0b due within 12 months, and liabilities of ₹14.5b due beyond 12 months. Offsetting this, it had ₹98.3b in cash and ₹10.6b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹11.6b.

Having regard to Ambuja Cements' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹765.6b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Ambuja Cements boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Ambuja Cements if management cannot prevent a repeat of the 49% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Ambuja Cements 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 company can only pay off debt with cold hard cash, not accounting profits. While Ambuja Cements 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. Over the last three years, Ambuja Cements reported free cash flow worth 5.9% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ambuja Cements has ₹97.8b in net cash. So we don't have any problem with Ambuja Cements's use of debt. 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 Ambuja Cements has 5 warning signs (and 2 which make us uncomfortable) we think you should know about.

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.

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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.