Here's Why DCM Shriram (NSE:DCMSHRIRAM) Can Manage Its Debt Responsibly

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. As with many other companies DCM Shriram Limited (NSE:DCMSHRIRAM) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for DCM Shriram

What Is DCM Shriram's Net 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. However, its balance sheet shows it holds ₹14.0b in cash, so it actually has ₹2.66b net cash.

How Strong Is DCM Shriram's Balance Sheet?

According to the last reported balance sheet, DCM Shriram had liabilities of ₹20.4b due within 12 months, and liabilities of ₹12.3b due beyond 12 months. Offsetting these obligations, it had cash of ₹14.0b as well as receivables valued at ₹9.94b due within 12 months. So it has liabilities totalling ₹8.74b more than its cash and near-term receivables, combined.

Since publicly traded DCM Shriram shares are worth a total of ₹70.0b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, DCM Shriram boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that DCM Shriram has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 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, 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. Looking at the most recent three years, DCM Shriram recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While DCM Shriram does have more liabilities than liquid assets, it also has net cash of ₹2.66b. So we are not troubled with DCM Shriram's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for DCM Shriram that you should be aware of.

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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