Does DCM Shriram (NSE:DCMSHRIRAM) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that DCM Shriram Limited (NSE:DCMSHRIRAM) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for DCM Shriram

What Is DCM Shriram's Debt?

You can click the graphic below for the historical numbers, but it shows that DCM Shriram had ₹11.4b of debt in September 2020, down from ₹16.2b, one year before. But on the other hand it also has ₹14.0b in cash, leading to a ₹2.66b net cash position.

A Look At DCM Shriram's Liabilities

We can see from the most recent balance sheet that DCM Shriram had liabilities of ₹20.4b falling due within a year, and liabilities of ₹12.3b due beyond that. Offsetting these obligations, it had cash of ₹14.0b as well as receivables valued at ₹9.94b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹8.74b.

Of course, DCM Shriram has a market capitalization of ₹50.4b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 fact DCM Shriram's saving grace is its low debt levels, because its EBIT has tanked 28% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is DCM Shriram's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Looking at the most recent three years, DCM Shriram recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although DCM Shriram's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹2.66b. So while DCM Shriram does not have a great balance sheet, it's certainly not too bad. 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. To that end, you should be aware of the 2 warning signs we've spotted with DCM Shriram .

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. 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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