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

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, NACL Industries Limited (NSE:NACLIND) does carry debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for NACL Industries

What Is NACL Industries's Debt?

You can click the graphic below for the historical numbers, but it shows that NACL Industries had ₹1.84b of debt in March 2021, down from ₹2.61b, one year before. However, because it has a cash reserve of ₹801.8m, its net debt is less, at about ₹1.04b.

How Strong Is NACL Industries' Balance Sheet?

According to the last reported balance sheet, NACL Industries had liabilities of ₹4.53b due within 12 months, and liabilities of ₹1.04b due beyond 12 months. Offsetting this, it had ₹801.8m in cash and ₹3.36b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.41b.

Since publicly traded NACL Industries shares are worth a total of ₹11.1b, it seems unlikely that this level of liabilities would be a major threat. 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 0.82 and interest cover of 3.7 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 107% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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 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. Over the most recent three years, NACL Industries recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, NACL Industries's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its interest cover does undermine this impression a bit. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that NACL Industries is showing 4 warning signs in our investment analysis , you should know about...

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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