Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Mishra Dhatu Nigam Limited (NSE:MIDHANI) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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.

View our latest analysis for Mishra Dhatu Nigam

What Is Mishra Dhatu Nigam's Debt?

As you can see below, at the end of March 2019, Mishra Dhatu Nigam had ₹1.07b of debt, up from ₹928.5m a year ago. Click the image for more detail. However, it does have ₹2.08b in cash offsetting this, leading to net cash of ₹1.01b.

How Strong Is Mishra Dhatu Nigam's Balance Sheet?

We can see from the most recent balance sheet that Mishra Dhatu Nigam had liabilities of ₹5.34b falling due within a year, and liabilities of ₹4.56b due beyond that. On the other hand, it had cash of ₹2.08b and ₹4.42b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.40b.

Of course, Mishra Dhatu Nigam has a market capitalization of ₹21.7b, 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. While it does have liabilities worth noting, Mishra Dhatu Nigam also has more cash than debt, so we're pretty confident it can manage its debt safely.

While Mishra Dhatu Nigam doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mishra Dhatu Nigam will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Mishra Dhatu Nigam 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, Mishra Dhatu Nigam reported free cash flow worth 11% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While Mishra Dhatu Nigam does have more liabilities than liquid assets, it also has net cash of ₹1.0b. So we don't have any problem with Mishra Dhatu Nigam's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Mishra Dhatu Nigam, you may well want to click here to check an interactive graph of its earnings per share history.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.