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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Carborundum Universal Limited (NSE:CARBORUNIV) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Carborundum Universal Carry?
You can click the graphic below for the historical numbers, but it shows that Carborundum Universal had ₹422.8m of debt in September 2021, down from ₹658.9m, one year before. However, its balance sheet shows it holds ₹6.94b in cash, so it actually has ₹6.52b net cash.
How Strong Is Carborundum Universal's Balance Sheet?
According to the last reported balance sheet, Carborundum Universal had liabilities of ₹4.55b due within 12 months, and liabilities of ₹441.9m due beyond 12 months. Offsetting these obligations, it had cash of ₹6.94b as well as receivables valued at ₹4.95b due within 12 months. So it actually has ₹6.90b more liquid assets than total liabilities.
This short term liquidity is a sign that Carborundum Universal could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Carborundum Universal has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Carborundum Universal grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its 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 Carborundum Universal 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. Carborundum Universal 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, Carborundum Universal recorded free cash flow worth 67% 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.
While we empathize with investors who find debt concerning, you should keep in mind that Carborundum Universal has net cash of ₹6.52b, as well as more liquid assets than liabilities. And we liked the look of last year's 64% year-on-year EBIT growth. So is Carborundum Universal's debt a risk? It doesn't seem so to us. 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. Be aware that Carborundum Universal is showing 1 warning sign in our investment analysis , you should know about...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.