Is Asian Paints (NSE:ASIANPAINT) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Asian Paints Limited (NSE:ASIANPAINT) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Asian Paints

What Is Asian Paints's Debt?

The chart below, which you can click on for greater detail, shows that Asian Paints had ₹3.49b in debt in March 2021; about the same as the year before. However, its balance sheet shows it holds ₹47.7b in cash, so it actually has ₹44.2b net cash.

How Healthy Is Asian Paints' Balance Sheet?

According to the last reported balance sheet, Asian Paints had liabilities of ₹59.3b due within 12 months, and liabilities of ₹12.1b due beyond 12 months. Offsetting these obligations, it had cash of ₹47.7b as well as receivables valued at ₹28.7b due within 12 months. So it actually has ₹5.03b more liquid assets than total liabilities.

This state of affairs indicates that Asian Paints' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹2.92t company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Asian Paints has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Asian Paints has been able to increase its EBIT by 20% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Asian Paints 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. Asian Paints 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, Asian Paints recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Asian Paints has net cash of ₹44.2b, as well as more liquid assets than liabilities. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in ₹34b. So is Asian Paints's debt a risk? It doesn't seem so to us. We'd be very excited to see if Asian Paints insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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