Is Alkyl Amines Chemicals (NSE:ALKYLAMINE) 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, Alkyl Amines Chemicals Limited (NSE:ALKYLAMINE) does carry debt. But the real question is whether this debt is making the company risky.

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Alkyl Amines Chemicals

What Is Alkyl Amines Chemicals's Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Alkyl Amines Chemicals had debt of ₹877.5m, up from ₹232.9m in one year. However, it does have ₹171.9m in cash offsetting this, leading to net debt of about ₹705.6m.

How Strong Is Alkyl Amines Chemicals' Balance Sheet?

We can see from the most recent balance sheet that Alkyl Amines Chemicals had liabilities of ₹3.52b falling due within a year, and liabilities of ₹688.1m due beyond that. Offsetting these obligations, it had cash of ₹171.9m as well as receivables valued at ₹2.59b due within 12 months. So its liabilities total ₹1.45b more than the combination of its cash and short-term receivables.

Having regard to Alkyl Amines Chemicals' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹128.6b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Alkyl Amines Chemicals has a very light debt load indeed.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Alkyl Amines Chemicals's net debt is only 0.23 times its EBITDA. And its EBIT easily covers its interest expense, being 128 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that Alkyl Amines Chemicals has seen its EBIT plunge 11% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Alkyl Amines Chemicals'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Alkyl Amines Chemicals reported free cash flow worth 4.7% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Both Alkyl Amines Chemicals's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. Looking at all this data makes us feel a little cautious about Alkyl Amines Chemicals's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Alkyl Amines Chemicals you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.