Chemfab Alkalis (NSE:CHEMFAB) Takes On Some Risk With Its Use Of 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.' 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 Chemfab Alkalis Limited (NSE:CHEMFAB) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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.

Check out our latest analysis for Chemfab Alkalis

What Is Chemfab Alkalis's Debt?

As you can see below, at the end of March 2024, Chemfab Alkalis had ₹201.1m of debt, up from ₹23.6m a year ago. Click the image for more detail. But it also has ₹299.3m in cash to offset that, meaning it has ₹98.2m net cash.

How Strong Is Chemfab Alkalis' Balance Sheet?

The latest balance sheet data shows that Chemfab Alkalis had liabilities of ₹918.6m due within a year, and liabilities of ₹212.0m falling due after that. On the other hand, it had cash of ₹299.3m and ₹224.0m worth of receivables due within a year. So it has liabilities totalling ₹607.2m more than its cash and near-term receivables, combined.

Given Chemfab Alkalis has a market capitalization of ₹15.1b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Chemfab Alkalis also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Chemfab Alkalis's saving grace is its low debt levels, because its EBIT has tanked 67% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Chemfab Alkalis will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Chemfab Alkalis 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, Chemfab Alkalis created free cash flow amounting to 6.9% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

We could understand if investors are concerned about Chemfab Alkalis's liabilities, but we can be reassured by the fact it has has net cash of ₹98.2m. So although we see some areas for improvement, we're not too worried about Chemfab Alkalis's balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Chemfab Alkalis .

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.

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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.