Here's Why NMDC (NSE:NMDC) Can Manage Its Debt Responsibly

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

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for NMDC

What Is NMDC's Debt?

The chart below, which you can click on for greater detail, shows that NMDC had ₹21.4b in debt in September 2023; about the same as the year before. But on the other hand it also has ₹139.2b in cash, leading to a ₹117.8b net cash position.

How Healthy Is NMDC's Balance Sheet?

We can see from the most recent balance sheet that NMDC had liabilities of ₹66.5b falling due within a year, and liabilities of ₹14.4b due beyond that. Offsetting this, it had ₹139.2b in cash and ₹6.71b in receivables that were due within 12 months. So it actually has ₹65.0b more liquid assets than total liabilities.

This short term liquidity is a sign that NMDC could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, NMDC boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that NMDC's load is not too heavy, because its EBIT was down 20% 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 ultimately the future profitability of the business will decide if NMDC can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. NMDC 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. During the last three years, NMDC produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that NMDC has net cash of ₹117.8b, as well as more liquid assets than liabilities. So we are not troubled with NMDC's debt use. 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. For example, we've discovered 1 warning sign for NMDC that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.