Here's Why Deccan Cements (NSE:DECCANCE) Can Manage Its Debt Responsibly

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 note that Deccan Cements Limited (NSE:DECCANCE) does have debt on its balance sheet. But is this debt a concern to shareholders?

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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Deccan Cements

How Much Debt Does Deccan Cements Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Deccan Cements had debt of ₹722.3m, up from ₹510.8m in one year. But on the other hand it also has ₹1.90b in cash, leading to a ₹1.18b net cash position.

How Strong Is Deccan Cements' Balance Sheet?

The latest balance sheet data shows that Deccan Cements had liabilities of ₹1.68b due within a year, and liabilities of ₹1.17b falling due after that. Offsetting this, it had ₹1.90b in cash and ₹551.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹392.1m.

Since publicly traded Deccan Cements shares are worth a total of ₹5.58b, it seems unlikely that this level of liabilities would be a major threat. 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, Deccan Cements also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Deccan Cements grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Deccan Cements'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 Deccan Cements 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. In the last three years, Deccan Cements's free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

We could understand if investors are concerned about Deccan Cements's liabilities, but we can be reassured by the fact it has has net cash of ₹1.18b. And it impressed us with its EBIT growth of 67% over the last year. So is Deccan Cements's debt a risk? It doesn't seem so to us. 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. For example - Deccan Cements has 2 warning signs we think 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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