Is DCM Shriram (NSE:DCMSHRIRAM) Using Too Much Debt?

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.' 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. Importantly, DCM Shriram Limited (NSE:DCMSHRIRAM) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out 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 ₹12.6b of debt in March 2021, down from ₹21.6b, one year before. However, it does have ₹15.7b in cash offsetting this, leading to net cash of ₹3.13b.

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 ₹18.2b due within 12 months and liabilities of ₹13.2b due beyond that. Offsetting these obligations, it had cash of ₹15.7b as well as receivables valued at ₹4.71b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹11.0b.

Of course, DCM Shriram has a market capitalization of ₹130.8b, 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. 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 other side of the story is that DCM Shriram saw its EBIT decline by 7.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is DCM Shriram's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. DCM Shriram 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. Looking at the most recent three years, DCM Shriram recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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 ₹3.13b. So we don't have any problem with DCM Shriram's use of debt. 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. We've identified 3 warning signs with DCM Shriram , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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