Atul (NSE:ATUL) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Atul Ltd (NSE:ATUL) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Atul

How Much Debt Does Atul Carry?

The image below, which you can click on for greater detail, shows that Atul had debt of ₹950.1m at the end of March 2021, a reduction from ₹1.08b over a year. However, it does have ₹11.0b in cash offsetting this, leading to net cash of ₹10.1b.

How Healthy Is Atul's Balance Sheet?

According to the last reported balance sheet, Atul had liabilities of ₹8.06b due within 12 months, and liabilities of ₹2.74b due beyond 12 months. Offsetting this, it had ₹11.0b in cash and ₹7.33b in receivables that were due within 12 months. So it can boast ₹7.57b more liquid assets than total liabilities.

This short term liquidity is a sign that Atul could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Atul boasts net cash, so it's fair to say it does not have a heavy debt load!

While Atul doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Atul'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Atul has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Atul's free cash flow amounted to 50% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Atul has ₹10.1b in net cash and a decent-looking balance sheet. So we don't have any problem with Atul's use of debt. 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 Atul is showing 1 warning sign 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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