These 4 Measures Indicate That Tata Metaliks (NSE:TATAMETALI) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Tata Metaliks Limited (NSE:TATAMETALI) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Tata Metaliks

How Much Debt Does Tata Metaliks Carry?

As you can see below, at the end of September 2020, Tata Metaliks had ₹924.8m of debt, up from ₹829.3m a year ago. Click the image for more detail. But it also has ₹2.23b in cash to offset that, meaning it has ₹1.30b net cash.

A Look At Tata Metaliks's Liabilities

We can see from the most recent balance sheet that Tata Metaliks had liabilities of ₹4.07b falling due within a year, and liabilities of ₹1.03b due beyond that. Offsetting these obligations, it had cash of ₹2.23b as well as receivables valued at ₹2.14b due within 12 months. So it has liabilities totalling ₹726.5m more than its cash and near-term receivables, combined.

Since publicly traded Tata Metaliks shares are worth a total of ₹19.2b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Tata Metaliks boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Tata Metaliks grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tata Metaliks 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Tata Metaliks 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. Looking at the most recent three years, Tata Metaliks recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

We could understand if investors are concerned about Tata Metaliks's liabilities, but we can be reassured by the fact it has has net cash of ₹1.30b. And we liked the look of last year's 26% year-on-year EBIT growth. So is Tata Metaliks'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. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Tata Metaliks you should be aware of, and 1 of them is significant.

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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