DCM Shriram (NSE:DCMSHRIRAM) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 DCM Shriram Limited (NSE:DCMSHRIRAM) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for DCM Shriram

What Is DCM Shriram's Debt?

As you can see below, DCM Shriram had ₹15.1b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₹16.1b in cash offsetting this, leading to net cash of ₹980.3m.

How Healthy Is DCM Shriram's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that DCM Shriram had liabilities of ₹23.8b due within 12 months and liabilities of ₹14.9b due beyond that. On the other hand, it had cash of ₹16.1b and ₹9.11b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹13.5b.

Of course, DCM Shriram has a market capitalization of ₹151.2b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, DCM Shriram also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that DCM Shriram has boosted its EBIT by 71%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since DCM Shriram will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While DCM Shriram 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 most recent three years, DCM Shriram recorded free cash flow worth 57% 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

We could understand if investors are concerned about DCM Shriram's liabilities, but we can be reassured by the fact it has has net cash of ₹980.3m. And we liked the look of last year's 71% year-on-year EBIT growth. So we don't think DCM Shriram'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. We've identified 1 warning sign with DCM Shriram , and understanding them should be part of your investment process.

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.