These 4 Measures Indicate That Atul (NSE:ATUL) Is Using Debt Reasonably Well

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. We note that Atul Ltd (NSE:ATUL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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.

See 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 ₹312.5m at the end of September 2021, a reduction from ₹1.17b over a year. But it also has ₹6.86b in cash to offset that, meaning it has ₹6.55b net cash.

How Healthy Is Atul's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Atul had liabilities of ₹7.98b due within 12 months and liabilities of ₹2.24b due beyond that. Offsetting this, it had ₹6.86b in cash and ₹9.12b in receivables that were due within 12 months. So it actually has ₹5.75b 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. Simply put, the fact that Atul has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Atul grew its EBIT by 9.6% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Atul can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. 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. In the last three years, Atul's free cash flow amounted to 38% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Atul has ₹6.55b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 9.6% over the last year. 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. 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.

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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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.