We Think Mangalam Drugs & Organics (NSE:MANGALAM) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Mangalam Drugs & Organics Limited (NSE:MANGALAM) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Mangalam Drugs & Organics

How Much Debt Does Mangalam Drugs & Organics Carry?

You can click the graphic below for the historical numbers, but it shows that Mangalam Drugs & Organics had ₹460.3m of debt in March 2020, down from ₹629.0m, one year before. However, it does have ₹16.3m in cash offsetting this, leading to net debt of about ₹444.0m.

A Look At Mangalam Drugs & Organics's Liabilities

The latest balance sheet data shows that Mangalam Drugs & Organics had liabilities of ₹1.09b due within a year, and liabilities of ₹172.6m falling due after that. On the other hand, it had cash of ₹16.3m and ₹399.9m worth of receivables due within a year. So its liabilities total ₹851.1m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₹1.16b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Even though Mangalam Drugs & Organics's debt is only 1.8, its interest cover is really very low at 1.6. This does have us wondering if the company pays high interest because it is considered risky. Either way there's no doubt the stock is using meaningful leverage. Pleasingly, Mangalam Drugs & Organics is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 494% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Mangalam Drugs & Organics will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Mangalam Drugs & Organics produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Mangalam Drugs & Organics's EBIT growth rate was a real positive on this analysis, as was its conversion of EBIT to free cash flow. But truth be told its interest cover had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that Mangalam Drugs & Organics is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for Mangalam Drugs & Organics (of which 2 are concerning!) you should know about.

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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