Kakatiya Cement Sugar and Industries (NSE:KAKATCEM) Could Easily Take On More 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.' 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 note that Kakatiya Cement Sugar and Industries Limited (NSE:KAKATCEM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Kakatiya Cement Sugar and Industries

What Is Kakatiya Cement Sugar and Industries's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Kakatiya Cement Sugar and Industries had debt of ₹289.2m, up from ₹194.8m in one year. However, it does have ₹1.75b in cash offsetting this, leading to net cash of ₹1.46b.

How Healthy Is Kakatiya Cement Sugar and Industries' Balance Sheet?

According to the last reported balance sheet, Kakatiya Cement Sugar and Industries had liabilities of ₹712.9m due within 12 months, and liabilities of ₹99.1m due beyond 12 months. Offsetting these obligations, it had cash of ₹1.75b as well as receivables valued at ₹214.9m due within 12 months. So it can boast ₹1.15b more liquid assets than total liabilities.

This surplus liquidity suggests that Kakatiya Cement Sugar and Industries' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Kakatiya Cement Sugar and Industries has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Kakatiya Cement Sugar and Industries's saving grace is its low debt levels, because its EBIT has tanked 43% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kakatiya Cement Sugar and Industries's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Kakatiya Cement Sugar and 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. Over the last two years, Kakatiya Cement Sugar and Industries actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kakatiya Cement Sugar and Industries has net cash of ₹1.46b, as well as more liquid assets than liabilities. The cherry on top was that in converted 923% of that EBIT to free cash flow, bringing in ₹531m. So we don't think Kakatiya Cement Sugar and Industries's use of debt is risky. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Kakatiya Cement Sugar and Industries (at least 1 which is significant) , and understanding them should be part of your investment process.

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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