Dalmia Bharat (NSE:DALBHARAT) Seems To Use Debt Quite Sensibly

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.' 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. We note that Dalmia Bharat Limited (NSE:DALBHARAT) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Dalmia Bharat

How Much Debt Does Dalmia Bharat Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Dalmia Bharat had debt of ₹33.7b, up from ₹31.4b in one year. On the flip side, it has ₹26.4b in cash leading to net debt of about ₹7.29b.

How Healthy Is Dalmia Bharat's Balance Sheet?

According to the last reported balance sheet, Dalmia Bharat had liabilities of ₹43.1b due within 12 months, and liabilities of ₹41.2b due beyond 12 months. On the other hand, it had cash of ₹26.4b and ₹7.04b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹50.9b.

Of course, Dalmia Bharat has a market capitalization of ₹344.6b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Dalmia Bharat has a low net debt to EBITDA ratio of only 0.30. And its EBIT covers its interest expense a whopping 10.2 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that Dalmia Bharat has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dalmia Bharat'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Dalmia Bharat produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Dalmia Bharat's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its net debt to EBITDA. When we consider all the factors mentioned above, we do feel a bit cautious about Dalmia Bharat's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more 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 instance, we've identified 1 warning sign for Dalmia Bharat that you should be aware of.

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. 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.