We Think Chambal Fertilisers and Chemicals (NSE:CHAMBLFERT) Can Stay On Top Of Its 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. We note that Chambal Fertilisers and Chemicals Limited (NSE:CHAMBLFERT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Chambal Fertilisers and Chemicals

What Is Chambal Fertilisers and Chemicals's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Chambal Fertilisers and Chemicals had debt of ₹43.4b, up from ₹31.6b in one year. On the flip side, it has ₹5.54b in cash leading to net debt of about ₹37.8b.

A Look At Chambal Fertilisers and Chemicals' Liabilities

Zooming in on the latest balance sheet data, we can see that Chambal Fertilisers and Chemicals had liabilities of ₹38.0b due within 12 months and liabilities of ₹31.0b due beyond that. Offsetting this, it had ₹5.54b in cash and ₹21.8b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹41.7b.

Chambal Fertilisers and Chemicals has a market capitalization of ₹151.6b, 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 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Chambal Fertilisers and Chemicals's moderate net debt to EBITDA ratio ( being 1.7), indicates prudence when it comes to debt. And its commanding EBIT of 16.0 times its interest expense, implies the debt load is as light as a peacock feather. But the other side of the story is that Chambal Fertilisers and Chemicals saw its EBIT decline by 7.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Chambal Fertilisers and Chemicals's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Chambal Fertilisers and Chemicals actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Chambal Fertilisers and Chemicals's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that Chambal Fertilisers and Chemicals can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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 3 warning signs for Chambal Fertilisers and Chemicals you should be aware of, and 1 of them is significant.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.