Chambal Fertilisers and Chemicals (NSE:CHAMBLFERT) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 can see that Chambal Fertilisers and Chemicals Limited (NSE:CHAMBLFERT) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Chambal Fertilisers and Chemicals

What Is Chambal Fertilisers and Chemicals's Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Chambal Fertilisers and Chemicals had debt of ₹69.2b, up from ₹35.9b in one year. Net debt is about the same, since the it doesn't have much cash.

How Strong Is Chambal Fertilisers and Chemicals' Balance Sheet?

According to the last reported balance sheet, Chambal Fertilisers and Chemicals had liabilities of ₹92.6b due within 12 months, and liabilities of ₹29.5b due beyond 12 months. Offsetting these obligations, it had cash of ₹758.4m as well as receivables valued at ₹81.5b due within 12 months. So it has liabilities totalling ₹39.8b more than its cash and near-term receivables, combined.

Chambal Fertilisers and Chemicals has a market capitalization of ₹125.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Chambal Fertilisers and Chemicals has net debt to EBITDA of 3.4 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 9.8 suggests it can easily service that debt. Unfortunately, Chambal Fertilisers and Chemicals's EBIT flopped 20% over the last four quarters. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. 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 Chambal Fertilisers and Chemicals 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Chambal Fertilisers and Chemicals produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Chambal Fertilisers and Chemicals's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its interest cover was refreshing. We think that Chambal Fertilisers and Chemicals's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 5 warning signs for Chambal Fertilisers and Chemicals (2 are concerning!) that you should be aware of before investing here.

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.