Here's Why Hindustan Zinc (NSE:HINDZINC) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Hindustan Zinc Limited (NSE:HINDZINC) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hindustan Zinc

What Is Hindustan Zinc's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Hindustan Zinc had ₹121.9b of debt, an increase on ₹31.2b, over one year. However, because it has a cash reserve of ₹112.6b, its net debt is less, at about ₹9.26b.

How Healthy Is Hindustan Zinc's Balance Sheet?

We can see from the most recent balance sheet that Hindustan Zinc had liabilities of ₹174.5b falling due within a year, and liabilities of ₹50.8b due beyond that. Offsetting this, it had ₹112.6b in cash and ₹14.2b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹98.6b.

Of course, Hindustan Zinc has a titanic market capitalization of ₹1.33t, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Hindustan Zinc has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.059 times EBITDA and EBIT covering interest a whopping 24.4 times, it's clear that Hindustan Zinc is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. On the other hand, Hindustan Zinc's EBIT dived 17%, over the last year. 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 it is future earnings, more than anything, that will determine Hindustan Zinc's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Hindustan Zinc recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Hindustan Zinc's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. Taking all this data into account, it seems to us that Hindustan Zinc takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Hindustan Zinc that you should be aware of before investing here.

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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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.