Is Bodal Chemicals (NSE:BODALCHEM) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Bodal Chemicals Limited (NSE:BODALCHEM) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Bodal Chemicals

What Is Bodal Chemicals's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Bodal Chemicals had debt of ₹4.84b, up from ₹1.88b in one year. However, it does have ₹204.0m in cash offsetting this, leading to net debt of about ₹4.64b.

How Healthy Is Bodal Chemicals' Balance Sheet?

According to the last reported balance sheet, Bodal Chemicals had liabilities of ₹6.25b due within 12 months, and liabilities of ₹1.71b due beyond 12 months. On the other hand, it had cash of ₹204.0m and ₹4.86b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.89b.

Given Bodal Chemicals has a market capitalization of ₹15.0b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Bodal Chemicals's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its strong interest cover of 13.0 times, makes us even more comfortable. Pleasingly, Bodal Chemicals is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 259% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Bodal Chemicals will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Bodal Chemicals burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Bodal Chemicals's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Considering this range of data points, we think Bodal Chemicals is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. To that end, you should learn about the 4 warning signs we've spotted with Bodal Chemicals (including 3 which don't sit too well with us) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.