Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Advanced Enzyme Technologies Limited (NSE:ADVENZYMES) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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.
How Much Debt Does Advanced Enzyme Technologies Carry?
As you can see below, Advanced Enzyme Technologies had ₹197.7m of debt at March 2020, down from ₹350.3m a year prior. However, its balance sheet shows it holds ₹2.08b in cash, so it actually has ₹1.88b net cash.
A Look At Advanced Enzyme Technologies's Liabilities
According to the last reported balance sheet, Advanced Enzyme Technologies had liabilities of ₹650.2m due within 12 months, and liabilities of ₹461.4m due beyond 12 months. Offsetting this, it had ₹2.08b in cash and ₹777.3m in receivables that were due within 12 months. So it actually has ₹1.74b more liquid assets than total liabilities.
This surplus suggests that Advanced Enzyme Technologies has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Advanced Enzyme Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.
Fortunately, Advanced Enzyme Technologies grew its EBIT by 8.5% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Advanced Enzyme Technologies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Advanced Enzyme Technologies 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. Over the most recent three years, Advanced Enzyme Technologies recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Advanced Enzyme Technologies has ₹1.88b in net cash and a decent-looking balance sheet. So is Advanced Enzyme Technologies's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Advanced Enzyme Technologies is showing 2 warning signs in our investment analysis , 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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