Is Finolex Industries (NSE:FINPIPE) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Finolex Industries Limited (NSE:FINPIPE) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that FINPIPE is potentially undervalued!

What Is Finolex Industries's Debt?

The image below, which you can click on for greater detail, shows that Finolex Industries had debt of ₹271.6m at the end of September 2022, a reduction from ₹301.6m over a year. But on the other hand it also has ₹11.2b in cash, leading to a ₹10.9b net cash position.

How Healthy Is Finolex Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Finolex Industries had liabilities of ₹6.95b due within 12 months and liabilities of ₹2.10b due beyond that. On the other hand, it had cash of ₹11.2b and ₹2.81b worth of receivables due within a year. So it actually has ₹4.96b more liquid assets than total liabilities.

This surplus suggests that Finolex Industries has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Finolex Industries has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Finolex Industries's saving grace is its low debt levels, because its EBIT has tanked 65% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Finolex Industries can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Finolex Industries 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, Finolex Industries recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Finolex Industries has ₹10.9b in net cash and a decent-looking balance sheet. So we don't have any problem with Finolex Industries'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. Case in point: We've spotted 4 warning signs for Finolex Industries you should be aware of, and 1 of them is a bit concerning.

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.