Trent (NSE:TRENT) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Trent Limited (NSE:TRENT) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Trent

What Is Trent's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Trent had ₹4.97b of debt, an increase on none, over one year. But it also has ₹6.85b in cash to offset that, meaning it has ₹1.88b net cash.

How Healthy Is Trent's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Trent had liabilities of ₹5.15b due within 12 months and liabilities of ₹34.6b due beyond that. On the other hand, it had cash of ₹6.85b and ₹391.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹32.5b.

Of course, Trent has a market capitalization of ₹383.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Trent boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that Trent improved its EBIT from a last year's loss to a positive ₹1.9b. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Trent 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Trent 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. In the last year, Trent's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

We could understand if investors are concerned about Trent's liabilities, but we can be reassured by the fact it has has net cash of ₹1.88b. So we don't have any problem with Trent's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Trent that you should be aware of before investing here.

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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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.