Hatsun Agro Product (NSE:HATSUN) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Hatsun Agro Product Limited (NSE:HATSUN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hatsun Agro Product

How Much Debt Does Hatsun Agro Product Carry?

As you can see below, Hatsun Agro Product had ₹11.0b of debt at March 2021, down from ₹12.0b a year prior. However, it also had ₹666.8m in cash, and so its net debt is ₹10.4b.

How Healthy Is Hatsun Agro Product's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hatsun Agro Product had liabilities of ₹13.4b due within 12 months and liabilities of ₹7.58b due beyond that. Offsetting this, it had ₹666.8m in cash and ₹90.7m in receivables that were due within 12 months. So its liabilities total ₹20.2b more than the combination of its cash and short-term receivables.

Since publicly traded Hatsun Agro Product shares are worth a total of ₹198.6b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

While Hatsun Agro Product's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.2 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Hatsun Agro Product grew its EBIT by 82% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hatsun Agro Product 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Hatsun Agro Product produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Hatsun Agro Product's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its interest cover. When we consider the range of factors above, it looks like Hatsun Agro Product is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Hatsun Agro Product you should be aware of.

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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