These 4 Measures Indicate That RHI Magnesita India (NSE:RHIM) Is Using Debt Reasonably Well

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 note that RHI Magnesita India Limited (NSE:RHIM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for RHI Magnesita India

What Is RHI Magnesita India's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 RHI Magnesita India had ₹619.8m of debt, an increase on ₹15.0m, over one year. However, its balance sheet shows it holds ₹820.0m in cash, so it actually has ₹200.2m net cash.

A Look At RHI Magnesita India's Liabilities

The latest balance sheet data shows that RHI Magnesita India had liabilities of ₹6.45b due within a year, and liabilities of ₹624.8m falling due after that. On the other hand, it had cash of ₹820.0m and ₹4.31b worth of receivables due within a year. So its liabilities total ₹1.95b more than the combination of its cash and short-term receivables.

This state of affairs indicates that RHI Magnesita India's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹98.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, RHI Magnesita India also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that RHI Magnesita India grew its EBIT by 199% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 RHI Magnesita India 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 company can only pay off debt with cold hard cash, not accounting profits. RHI Magnesita India 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 last three years, RHI Magnesita India reported free cash flow worth 4.6% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that RHI Magnesita India has ₹200.2m in net cash. And it impressed us with its EBIT growth of 199% over the last year. So is RHI Magnesita India's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 3 warning signs for RHI Magnesita India you should be aware of.

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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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.