We Think Tamilnadu Petroproducts (NSE:TNPETRO) Can Stay On Top Of Its Debt

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.' 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. We note that Tamilnadu Petroproducts Limited (NSE:TNPETRO) does have debt on its balance sheet. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Tamilnadu Petroproducts

What Is Tamilnadu Petroproducts's Debt?

As you can see below, at the end of September 2020, Tamilnadu Petroproducts had ₹736.4m of debt, up from ₹681.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹2.54b in cash, so it actually has ₹1.80b net cash.

How Healthy Is Tamilnadu Petroproducts' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tamilnadu Petroproducts had liabilities of ₹1.98b due within 12 months and liabilities of ₹540.4m due beyond that. Offsetting these obligations, it had cash of ₹2.54b as well as receivables valued at ₹595.4m due within 12 months. So it actually has ₹609.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Tamilnadu Petroproducts could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Tamilnadu Petroproducts has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Tamilnadu Petroproducts saw its EBIT drop by 8.3% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tamilnadu Petroproducts's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tamilnadu Petroproducts has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Tamilnadu Petroproducts recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While it is always sensible to investigate a company's debt, in this case Tamilnadu Petroproducts has ₹1.80b in net cash and a decent-looking balance sheet. So we are not troubled with Tamilnadu Petroproducts's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Tamilnadu Petroproducts that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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