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. As with many other companies Mazda Limited (NSE:MAZDALTD) makes use of debt. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
View our latest analysis for Mazda
What Is Mazda's Net Debt?
The image below, which you can click on for greater detail, shows that Mazda had debt of ₹17.9m at the end of March 2019, a reduction from ₹26.8m over a year. But it also has ₹478.3m in cash to offset that, meaning it has ₹460.4m net cash.
How Healthy Is Mazda's Balance Sheet?
The latest balance sheet data shows that Mazda had liabilities of ₹353.7m due within a year, and liabilities of ₹33.8m falling due after that. Offsetting these obligations, it had cash of ₹478.3m as well as receivables valued at ₹305.0m due within 12 months. So it can boast ₹395.8m more liquid assets than total liabilities.
This surplus suggests that Mazda is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Mazda has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Mazda grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Mazda'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 Mazda 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. During the last three years, Mazda burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.