Does NACL Industries (NSE:NACLIND) Have A Healthy Balance Sheet?

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. We can see that NACL Industries Limited (NSE:NACLIND) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for NACL Industries

What Is NACL Industries's Debt?

The image below, which you can click on for greater detail, shows that NACL Industries had debt of ₹1.93b at the end of September 2020, a reduction from ₹2.76b over a year. However, because it has a cash reserve of ₹1.30b, its net debt is less, at about ₹631.1m.

A Look At NACL Industries' Liabilities

According to the last reported balance sheet, NACL Industries had liabilities of ₹5.71b due within 12 months, and liabilities of ₹470.0m due beyond 12 months. On the other hand, it had cash of ₹1.30b and ₹3.31b worth of receivables due within a year. So its liabilities total ₹1.57b more than the combination of its cash and short-term receivables.

Of course, NACL Industries has a market capitalization of ₹8.08b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 0.68 and interest cover of 3.0 times, it seems to us that NACL Industries is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Pleasingly, NACL Industries is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 9,676% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is NACL Industries's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, NACL Industries actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, NACL Industries's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its interest cover has the opposite effect. Looking at the bigger picture, we think NACL Industries's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for NACL Industries you should be aware of, and 1 of them is concerning.

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. 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.
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