Is Mangalore Chemicals & Fertilizers (NSE:MANGCHEFER) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Mangalore Chemicals & Fertilizers Limited (NSE:MANGCHEFER) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Mangalore Chemicals & Fertilizers

What Is Mangalore Chemicals & Fertilizers's Net Debt?

The image below, which you can click on for greater detail, shows that Mangalore Chemicals & Fertilizers had debt of ₹14.4b at the end of March 2020, a reduction from ₹17.1b over a year. However, because it has a cash reserve of ₹2.72b, its net debt is less, at about ₹11.6b.

A Look At Mangalore Chemicals & Fertilizers's Liabilities

Zooming in on the latest balance sheet data, we can see that Mangalore Chemicals & Fertilizers had liabilities of ₹20.1b due within 12 months and liabilities of ₹2.49b due beyond that. Offsetting these obligations, it had cash of ₹2.72b as well as receivables valued at ₹14.5b due within 12 months. So it has liabilities totalling ₹5.4b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₹3.97b, we think shareholders really should watch Mangalore Chemicals & Fertilizers's debt levels, like a parent watching their child ride a bike for the first time. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 5.5 hit our confidence in Mangalore Chemicals & Fertilizers like a one-two punch to the gut. The debt burden here is substantial. The good news is that Mangalore Chemicals & Fertilizers improved its EBIT by 8.9% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Mangalore Chemicals & Fertilizers's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Mangalore Chemicals & Fertilizers produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Mangalore Chemicals & Fertilizers's net debt to EBITDA left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Mangalore Chemicals & Fertilizers has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Mangalore Chemicals & Fertilizers (at least 1 which is significant) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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