Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Alembic Pharmaceuticals Limited (NSE:APLLTD) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
Check out our latest analysis for Alembic Pharmaceuticals
What is Alembic Pharmaceuticals’ debt?
As you can see below, at the end of March 2022, Alembic Pharmaceuticals had a debt of ₹6.30 billion, up from ₹5.00 billion a year ago. Click on the image for more details. However, since he has a cash reserve of ₹694.3 million, his net debt is lower at around ₹5.61 billion.
How strong is Alembic Pharmaceuticals’ balance sheet?
The latest balance sheet data shows that Alembic Pharmaceuticals had liabilities of ₹17.2 billion due within one year, and liabilities of ₹1.68 billion falling due thereafter. As compensation for these obligations, it had cash of ₹694.3 million as well as receivables valued at ₹8.32 billion due within 12 months. Thus, its liabilities total ₹9.83 billion more than the combination of its cash and short-term receivables.
Considering that Alembic Pharmaceuticals has a market capitalization of ₹144.2 billion, it is hard to believe that these liabilities pose a big threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Alembic Pharmaceuticals has a low net debt to EBITDA ratio of just 0.64. And its EBIT easily covers its interest charges, which is 33.1 times the size. So we’re pretty relaxed about his super conservative use of debt. In fact, Alembic Pharmaceuticals’ saving grace is its low level of leverage, as its EBIT has fallen 55% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Alembic Pharmaceuticals’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Alembic Pharmaceuticals’ free cash flow has been 22% of its EBIT, less than expected. That’s not great when it comes to paying off debt.
Our point of view
Neither Alembic Pharmaceuticals’ ability to grow EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But his coverage of interest tells a very different story and suggests a certain resilience. We think Alembic Pharmaceuticals’ debt makes it a bit risky, after looking at the aforementioned data points together. Not all risk is bad, as it can increase stock price returns if it pays off, but this leverage risk is worth keeping in mind. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example – Alembic Pharmaceuticals has 2 warning signs we think you should know.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.