Stock Analysis

Is NLC India (NSE:NLCINDIA) A Risky Investment?

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NSEI:NLCINDIA
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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 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 NLC India Limited (NSE:NLCINDIA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 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 NLC India

What Is NLC India's Debt?

You can click the graphic below for the historical numbers, but it shows that NLC India had ₹220.9b of debt in March 2022, down from ₹273.7b, one year before. However, it also had ₹7.69b in cash, and so its net debt is ₹213.2b.

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NSEI:NLCINDIA Debt to Equity History September 7th 2022

How Healthy Is NLC India's Balance Sheet?

The latest balance sheet data shows that NLC India had liabilities of ₹62.5b due within a year, and liabilities of ₹271.6b falling due after that. Offsetting this, it had ₹7.69b in cash and ₹37.4b in receivables that were due within 12 months. So it has liabilities totalling ₹289.1b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₹113.6b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, NLC India would probably need a major re-capitalization if its creditors were to demand repayment.

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.

NLC India has a debt to EBITDA ratio of 4.0 and its EBIT covered its interest expense 3.6 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, one redeeming factor is that NLC India grew its EBIT at 15% over the last 12 months, boosting its ability to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is NLC India'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, NLC India generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

NLC India's level of total liabilities and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. When we consider all the factors discussed, it seems to us that NLC India is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should learn about the 3 warning signs we've spotted with NLC India (including 1 which doesn't sit too well with us) .

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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