The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Mahindra Logistics Limited (NSE:MAHLOG) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Mahindra Logistics
How Much Debt Does Mahindra Logistics Carry?
You can click the graphic below for the historical numbers, but it shows that Mahindra Logistics had ₹299.1m of debt in September 2020, down from ₹1.39b, one year before. However, it does have ₹5.19b in cash offsetting this, leading to net cash of ₹4.89b.
How Healthy Is Mahindra Logistics’ Balance Sheet?
We can see from the most recent balance sheet that Mahindra Logistics had liabilities of ₹8.80b falling due within a year, and liabilities of ₹1.24b due beyond that. On the other hand, it had cash of ₹5.19b and ₹4.82b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Having regard to Mahindra Logistics’ size, it seems that its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine that the ₹34.2b company is struggling for cash, we still think it’s worth monitoring its balance sheet. Despite its noteworthy liabilities, Mahindra Logistics boasts net cash, so it’s fair to say it does not have a heavy debt load!
Importantly, Mahindra Logistics’s EBIT fell a jaw-dropping 61% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Mahindra Logistics’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Mahindra Logistics 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, Mahindra Logistics recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
Summing up
We could understand if investors are concerned about Mahindra Logistics’s liabilities, but we can be reassured by the fact it has has net cash of ₹4.89b. The cherry on top was that in converted 92% of that EBIT to free cash flow, bringing in ₹1.6b. So we don’t have any problem with Mahindra Logistics’s use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 2 warning signs for Mahindra Logistics that you should be aware of.
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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