Atul (NSE:ATUL) Takes On Some Risk With Its Use Of 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.' 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. Importantly, Atul Ltd (NSE:ATUL) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Atul

How Much Debt Does Atul Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Atul had ₹1.57b of debt, an increase on ₹677.0m, over one year. But it also has ₹3.69b in cash to offset that, meaning it has ₹2.12b net cash.

How Strong Is Atul's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Atul had liabilities of ₹8.15b due within 12 months and liabilities of ₹3.33b due beyond that. Offsetting these obligations, it had cash of ₹3.69b as well as receivables valued at ₹9.07b due within 12 months. So it can boast ₹1.28b more liquid assets than total liabilities.

Having regard to Atul's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹184.2b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Atul has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Atul if management cannot prevent a repeat of the 41% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Atul 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. Considering the last three years, Atul actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Atul has net cash of ₹2.12b, as well as more liquid assets than liabilities. So while Atul does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Atul you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.