Is Reliance Chemotex Industries (NSE:RELCHEMQ) A Risky Investment?

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 note that Reliance Chemotex Industries Limited (NSE:RELCHEMQ) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Reliance Chemotex Industries

How Much Debt Does Reliance Chemotex Industries Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Reliance Chemotex Industries had ₹2.79b of debt, an increase on ₹1.96b, over one year. On the flip side, it has ₹505.9m in cash leading to net debt of about ₹2.28b.

How Strong Is Reliance Chemotex Industries' Balance Sheet?

According to the last reported balance sheet, Reliance Chemotex Industries had liabilities of ₹1.64b due within 12 months, and liabilities of ₹1.84b due beyond 12 months. On the other hand, it had cash of ₹505.9m and ₹61.5m worth of receivables due within a year. So its liabilities total ₹2.91b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹1.65b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Reliance Chemotex Industries 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.1 times and a disturbingly high net debt to EBITDA ratio of 7.3 hit our confidence in Reliance Chemotex Industries like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Another concern for investors might be that Reliance Chemotex Industries's EBIT fell 18% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. There's no doubt that we learn most about debt from the balance sheet. But it is Reliance Chemotex Industries'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Reliance Chemotex Industries 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

On the face of it, Reliance Chemotex Industries's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its net debt to EBITDA fails to inspire much confidence. It looks to us like Reliance Chemotex Industries carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Reliance Chemotex Industries (at least 2 which are significant) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com