Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that National Aluminium Company Limited (NSE:NATIONALUM) 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
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What Is National Aluminium's Debt?
The image below, which you can click on for greater detail, shows that at March 2023 National Aluminium had debt of ₹477.5m, up from ₹206.7m in one year. But on the other hand it also has ₹22.6b in cash, leading to a ₹22.2b net cash position.
How Strong Is National Aluminium's Balance Sheet?
According to the last reported balance sheet, National Aluminium had liabilities of ₹28.9b due within 12 months, and liabilities of ₹16.1b due beyond 12 months. On the other hand, it had cash of ₹22.6b and ₹1.49b worth of receivables due within a year. So it has liabilities totalling ₹20.9b more than its cash and near-term receivables, combined.
Since publicly traded National Aluminium shares are worth a total of ₹149.5b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, National Aluminium also has more cash than debt, so we're pretty confident it can manage its debt safely.
The modesty of its debt load may become crucial for National Aluminium if management cannot prevent a repeat of the 56% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine National Aluminium's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. National Aluminium 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. In the last three years, National Aluminium's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
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 ₹22.2b. So we are not troubled with National Aluminium's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for National Aluminium (1 doesn't sit too well with us) you should be aware of.
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.
About NSEI:NATIONALUM
National Aluminium
Engages in the manufacture and sale of alumina and aluminum products in India and internationally.
Solid track record with excellent balance sheet and pays a dividend.