Does HFCL (NSE:HFCL) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that HFCL Limited (NSE:HFCL) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for HFCL

How Much Debt Does HFCL Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 HFCL had ₹7.59b of debt, an increase on ₹7.10b, over one year. However, it also had ₹3.31b in cash, and so its net debt is ₹4.28b.

How Strong Is HFCL's Balance Sheet?

We can see from the most recent balance sheet that HFCL had liabilities of ₹21.8b falling due within a year, and liabilities of ₹1.79b due beyond that. On the other hand, it had cash of ₹3.31b and ₹19.1b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.22b.

Having regard to HFCL's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹79.1b company is short on cash, but still worth keeping an eye on the balance sheet.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

HFCL has a low net debt to EBITDA ratio of only 0.72. And its EBIT easily covers its interest expense, being 11.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, HFCL's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is HFCL's earnings that will influence how the balance sheet holds up in the future. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, HFCL 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.

Our View

While HFCL's EBIT growth rate makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But at least its interest cover is a gleaming silver lining to those clouds. We think that HFCL's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of HFCL's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.