Is National Aluminium (NSE:NATIONALUM) A Risky Investment?

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 National Aluminium Company Limited (NSE:NATIONALUM) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for National Aluminium

How Much Debt Does National Aluminium Carry?

The image below, which you can click on for greater detail, shows that at March 2021 National Aluminium had debt of ₹1.33b, up from ₹123.1m in one year. However, it does have ₹20.0b in cash offsetting this, leading to net cash of ₹18.7b.

How Healthy Is National Aluminium's Balance Sheet?

According to the last reported balance sheet, National Aluminium had liabilities of ₹20.5b due within 12 months, and liabilities of ₹19.8b due beyond 12 months. Offsetting these obligations, it had cash of ₹20.0b as well as receivables valued at ₹2.63b due within 12 months. So it has liabilities totalling ₹17.7b more than its cash and near-term receivables, combined.

Given National Aluminium has a market capitalization of ₹149.5b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, National Aluminium boasts net cash, so it's fair to say it does not have a heavy debt load!

Although National Aluminium made a loss at the EBIT level, last year, it was also good to see that it generated ₹16b in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since National Aluminium will need earnings to service that debt. 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. While National Aluminium 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. Over the most recent year, National Aluminium recorded free cash flow worth 61% 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.

Summing up

Although National Aluminium's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹18.7b. So we don't have any problem with National Aluminium's use of debt. 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. We've identified 2 warning signs with National Aluminium (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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. 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.
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