Here's Why Oriental Carbon & Chemicals (NSE:OCCL) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Oriental Carbon & Chemicals Limited (NSE:OCCL) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Oriental Carbon & Chemicals

How Much Debt Does Oriental Carbon & Chemicals Carry?

As you can see below, at the end of September 2020, Oriental Carbon & Chemicals had ₹1.50b of debt, up from ₹1.14b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹1.71b in cash, so it actually has ₹208.1m net cash.

A Look At Oriental Carbon & Chemicals's Liabilities

Zooming in on the latest balance sheet data, we can see that Oriental Carbon & Chemicals had liabilities of ₹1.23b due within 12 months and liabilities of ₹1.29b due beyond that. On the other hand, it had cash of ₹1.71b and ₹709.5m worth of receivables due within a year. So its liabilities total ₹99.7m more than the combination of its cash and short-term receivables.

Having regard to Oriental Carbon & Chemicals's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹8.38b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Oriental Carbon & Chemicals also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Oriental Carbon & Chemicals's load is not too heavy, because its EBIT was down 29% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Oriental Carbon & Chemicals will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Oriental Carbon & Chemicals 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. Over the most recent three years, Oriental Carbon & Chemicals recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about Oriental Carbon & Chemicals's liabilities, but we can be reassured by the fact it has has net cash of ₹208.1m. So we are not troubled with Oriental Carbon & Chemicals'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 Oriental Carbon & Chemicals that you should be aware of before investing here.

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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