Here's Why Ortin Laboratories (NSE:ORTINLABSS) Is Weighed Down By Its Debt Load

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. Importantly, Ortin Laboratories Limited (NSE:ORTINLABSS) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Ortin Laboratories

How Much Debt Does Ortin Laboratories Carry?

The chart below, which you can click on for greater detail, shows that Ortin Laboratories had ₹195.7m in debt in March 2020; about the same as the year before. However, because it has a cash reserve of ₹28.5m, its net debt is less, at about ₹167.2m.

How Strong Is Ortin Laboratories's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ortin Laboratories had liabilities of ₹838.3m due within 12 months and liabilities of ₹88.7m due beyond that. On the other hand, it had cash of ₹28.5m and ₹371.5m worth of receivables due within a year. So it has liabilities totalling ₹527.0m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₹343.9m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Ortin Laboratories would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Ortin Laboratories's debt to EBITDA ratio (2.9) suggests that it uses some debt, its interest cover is very weak, at 1.2, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Even worse, Ortin Laboratories saw its EBIT tank 24% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Ortin Laboratories's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ortin Laboratories reported free cash flow worth 5.4% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Ortin Laboratories's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow fails to inspire much confidence. Considering all the factors previously mentioned, we think that Ortin Laboratories really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Ortin Laboratories is showing 4 warning signs in our investment analysis , and 3 of those are potentially serious...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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