Is Dr. Lal PathLabs (NSE:LALPATHLAB) Using Too Much Debt?

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.' 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. Importantly, Dr. Lal PathLabs Limited (NSE:LALPATHLAB) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Dr. Lal PathLabs

What Is Dr. Lal PathLabs's Debt?

You can click the graphic below for the historical numbers, but it shows that Dr. Lal PathLabs had ₹1.25b of debt in September 2023, down from ₹2.37b, one year before. But on the other hand it also has ₹8.97b in cash, leading to a ₹7.72b net cash position.

A Look At Dr. Lal PathLabs' Liabilities

According to the last reported balance sheet, Dr. Lal PathLabs had liabilities of ₹4.71b due within 12 months, and liabilities of ₹1.69b due beyond 12 months. On the other hand, it had cash of ₹8.97b and ₹867.0m worth of receivables due within a year. So it actually has ₹3.44b more liquid assets than total liabilities.

This state of affairs indicates that Dr. Lal PathLabs' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹218.6b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Dr. Lal PathLabs has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Dr. Lal PathLabs grew its EBIT at 16% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Dr. Lal PathLabs's ability to maintain a healthy balance sheet going forward. 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 produced sturdy free cash flow equating to 67% 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Dr. Lal PathLabs has ₹7.72b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 67% of that EBIT to free cash flow, bringing in ₹4.8b. 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. Be aware that Dr. Lal PathLabs is showing 2 warning signs in our investment analysis , you should know about...

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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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.