Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Dr. Lal PathLabs Limited (NSE:LALPATHLAB) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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 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.
How Much Debt Does Dr. Lal PathLabs Carry?
As you can see below, at the end of September 2021, Dr. Lal PathLabs had ₹1.54b of debt, up from ₹960.0m a year ago. Click the image for more detail. However, it does have ₹11.3b in cash offsetting this, leading to net cash of ₹9.72b.
A Look At Dr. Lal PathLabs' Liabilities
The latest balance sheet data shows that Dr. Lal PathLabs had liabilities of ₹3.36b due within a year, and liabilities of ₹1.15b falling due after that. Offsetting this, it had ₹11.3b in cash and ₹682.0m in receivables that were due within 12 months. So it actually has ₹7.43b more liquid assets than total liabilities.
This short term liquidity is a sign that Dr. Lal PathLabs could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Dr. Lal PathLabs boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Dr. Lal PathLabs has boosted its EBIT by 60%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Dr. Lal PathLabs can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Dr. Lal PathLabs may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Dr. Lal PathLabs generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case Dr. Lal PathLabs has ₹9.72b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹4.6b, being 91% of its EBIT. So we don't think Dr. Lal PathLabs's use of debt is risky. 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. To that end, you should be aware of the 3 warning signs we've spotted with Dr. Lal PathLabs .
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.
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.