Here's Why Mangalam Cement (NSE:MANGLMCEM) Has A Meaningful Debt Burden

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Mangalam Cement Limited (NSE:MANGLMCEM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Mangalam Cement

How Much Debt Does Mangalam Cement Carry?

As you can see below, at the end of September 2021, Mangalam Cement had ₹6.48b of debt, up from ₹5.02b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹2.15b, its net debt is less, at about ₹4.33b.

A Look At Mangalam Cement's Liabilities

We can see from the most recent balance sheet that Mangalam Cement had liabilities of ₹6.35b falling due within a year, and liabilities of ₹5.30b due beyond that. Offsetting this, it had ₹2.15b in cash and ₹545.3m in receivables that were due within 12 months. So its liabilities total ₹8.96b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₹9.68b, so it does suggest shareholders should keep an eye on Mangalam Cement's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Mangalam Cement's net debt of 1.7 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.7 times its interest expenses harmonizes with that theme. Also good is that Mangalam Cement grew its EBIT at 16% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Mangalam Cement 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Mangalam Cement's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Even if we have reservations about how easily Mangalam Cement is capable of staying on top of its total liabilities, its EBIT growth rate and interest cover make us think feel relatively unconcerned. Looking at all the angles mentioned above, it does seem to us that Mangalam Cement is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 instance, we've identified 2 warning signs for Mangalam Cement that you should be aware of.

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.