Is Atul (NSE:ATUL) 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Atul Ltd (NSE:ATUL) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for Atul

What Is Atul's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Atul had debt of ₹731.9m, up from ₹371.1m in one year. However, its balance sheet shows it holds ₹2.48b in cash, so it actually has ₹1.74b net cash.

A Look At Atul's Liabilities

Zooming in on the latest balance sheet data, we can see that Atul had liabilities of ₹9.70b due within 12 months and liabilities of ₹2.24b due beyond that. On the other hand, it had cash of ₹2.48b and ₹9.87b worth of receivables due within a year. So it can boast ₹402.7m more liquid assets than total liabilities.

This state of affairs indicates that Atul's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹205.7b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Atul boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Atul's EBIT dived 11%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Atul 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. 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. Over the last three years, Atul recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Atul has ₹1.74b in net cash and a decent-looking balance sheet. So we don't have any problem with Atul's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Atul's earnings per share history for free.

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.