We Think Hindalco Industries (NSE:HINDALCO) Is Taking Some Risk With Its 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.' 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. Importantly, Hindalco Industries Limited (NSE:HINDALCO) does carry debt. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hindalco Industries

How Much Debt Does Hindalco Industries Carry?

You can click the graphic below for the historical numbers, but it shows that Hindalco Industries had ₹645.1b of debt in September 2023, down from ₹676.7b, one year before. However, it does have ₹167.7b in cash offsetting this, leading to net debt of about ₹477.5b.

A Look At Hindalco Industries' Liabilities

Zooming in on the latest balance sheet data, we can see that Hindalco Industries had liabilities of ₹574.2b due within 12 months and liabilities of ₹678.2b due beyond that. On the other hand, it had cash of ₹167.7b and ₹168.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹916.0b.

This is a mountain of leverage even relative to its gargantuan market capitalization of ₹1.20t. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Hindalco Industries's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 4.8 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. The bad news is that Hindalco Industries saw its EBIT decline by 11% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hindalco 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Hindalco Industries produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

To be frank both Hindalco Industries's level of total liabilities and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Hindalco Industries's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Hindalco Industries that you should be aware of before investing here.

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. 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.