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. As with many other companies CMI Limited (NSE:CMI) makes use of debt. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for CMI
How Much Debt Does CMI Carry?
As you can see below, at the end of September 2018, CMI had ₹2.43b of debt, up from ₹1.77b a year ago. Click the image for more detail. However, it also had ₹127.0m in cash, and so its net debt is ₹2.31b.
How Healthy Is CMI's Balance Sheet?
We can see from the most recent balance sheet that CMI had liabilities of ₹3.59b falling due within a year, and liabilities of ₹422.0m due beyond that. Offsetting these obligations, it had cash of ₹127.0m as well as receivables valued at ₹2.43b due within 12 months. So it has liabilities totalling ₹1.46b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the ₹833.3m 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, CMI would probably need a major re-capitalization if its creditors were to demand repayment.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).