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.' 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 can see that Hindustan Zinc Limited (NSE:HINDZINC) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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 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, 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 Hindustan Zinc
What Is Hindustan Zinc's Net Debt?
As you can see below, Hindustan Zinc had ₹28.9b of debt at September 2022, down from ₹47.4b a year prior. However, it does have ₹178.3b in cash offsetting this, leading to net cash of ₹149.4b.
How Healthy Is Hindustan Zinc's Balance Sheet?
According to the last reported balance sheet, Hindustan Zinc had liabilities of ₹83.2b due within 12 months, and liabilities of ₹29.5b due beyond 12 months. On the other hand, it had cash of ₹178.3b and ₹3.73b worth of receivables due within a year. So it can boast ₹69.3b more liquid assets than total liabilities.
This short term liquidity is a sign that Hindustan Zinc could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hindustan Zinc has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Hindustan Zinc grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hindustan Zinc will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hindustan Zinc 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. During the last three years, Hindustan Zinc produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While it is always sensible to investigate a company's debt, in this case Hindustan Zinc has ₹149.4b in net cash and a decent-looking balance sheet. And we liked the look of last year's 39% year-on-year EBIT growth. So we don't think Hindustan Zinc's use of debt is risky. 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.
About NSEI:HINDZINC
Hindustan Zinc
Explores for, extracts, and processes minerals in India, rest of Asia, and internationally.
Acceptable track record with mediocre balance sheet.