Mahindra & Mahindra (NSE:M&M) Use Of Debt Could Be Considered Risky
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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Mahindra & Mahindra Limited (NSE:M&M) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Mahindra & Mahindra
What Is Mahindra & Mahindra's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2019 Mahindra & Mahindra had debt of ₹708.5b, up from ₹559.0b in one year. On the flip side, it has ₹150.9b in cash leading to net debt of about ₹557.5b.
How Healthy Is Mahindra & Mahindra's Balance Sheet?
According to the last reported balance sheet, Mahindra & Mahindra had liabilities of ₹587.4b due within 12 months, and liabilities of ₹563.0b due beyond 12 months. On the other hand, it had cash of ₹150.9b and ₹384.0b worth of receivables due within a year. So it has liabilities totalling ₹615.6b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's ₹557.4b market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner's social media. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While Mahindra & Mahindra's debt to EBITDA ratio (3.9) suggests that it uses some debt, its interest cover is very weak, at 2.2, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. More concerning, Mahindra & Mahindra saw its EBIT drop by 7.4% in the last twelve months. If that earnings trend continues the company will face an uphill battle to pay off its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Mahindra & Mahindra can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Mahindra & Mahindra burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
To be frank both Mahindra & Mahindra's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. And furthermore, its net debt to EBITDA also fails to instill confidence. Taking into account all the aforementioned factors, it looks like Mahindra & Mahindra has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Over time, share prices tend to follow earnings per share, so if you're interested in Mahindra & Mahindra, 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.
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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.
