Is Chambal Fertilisers and Chemicals (NSE:CHAMBLFERT) A Risky Investment?

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 can see that Chambal Fertilisers and Chemicals Limited (NSE:CHAMBLFERT) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Chambal Fertilisers and Chemicals

How Much Debt Does Chambal Fertilisers and Chemicals Carry?

As you can see below, Chambal Fertilisers and Chemicals had ₹33.4b of debt at March 2023, down from ₹43.2b a year prior. On the flip side, it has ₹18.9b in cash leading to net debt of about ₹14.4b.

A Look At Chambal Fertilisers and Chemicals' Liabilities

According to the last reported balance sheet, Chambal Fertilisers and Chemicals had liabilities of ₹31.5b due within 12 months, and liabilities of ₹25.7b due beyond 12 months. Offsetting this, it had ₹18.9b in cash and ₹17.6b in receivables that were due within 12 months. So it has liabilities totalling ₹20.6b more than its cash and near-term receivables, combined.

Since publicly traded Chambal Fertilisers and Chemicals shares are worth a total of ₹110.4b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Chambal Fertilisers and Chemicals's low debt to EBITDA ratio of 0.79 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.7 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Shareholders should be aware that Chambal Fertilisers and Chemicals's EBIT was down 24% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. 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 we always check how much of that EBIT is translated into free cash flow. Over the last three years, Chambal Fertilisers and Chemicals actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Based on what we've seen Chambal Fertilisers and Chemicals is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. Considering this range of data points, we think Chambal Fertilisers and 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Chambal Fertilisers and Chemicals has 2 warning signs we think 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.