Deepak Fertilisers And Petrochemicals (NSE:DEEPAKFERT) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Deepak Fertilisers And Petrochemicals Corporation Limited (NSE:DEEPAKFERT) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. 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 Deepak Fertilisers And Petrochemicals

What Is Deepak Fertilisers And Petrochemicals's Debt?

As you can see below, Deepak Fertilisers And Petrochemicals had ₹25.8b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₹11.7b in cash offsetting this, leading to net debt of about ₹14.2b.

A Look At Deepak Fertilisers And Petrochemicals' Liabilities

Zooming in on the latest balance sheet data, we can see that Deepak Fertilisers And Petrochemicals had liabilities of ₹22.4b due within 12 months and liabilities of ₹25.0b due beyond that. Offsetting this, it had ₹11.7b in cash and ₹6.21b in receivables that were due within 12 months. So its liabilities total ₹29.6b more than the combination of its cash and short-term receivables.

Deepak Fertilisers And Petrochemicals has a market capitalization of ₹78.2b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 1.0 times EBITDA, Deepak Fertilisers And Petrochemicals is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.3 times the interest expense over the last year. On top of that, Deepak Fertilisers And Petrochemicals grew its EBIT by 50% over the last twelve months, and that growth will make it easier to handle its debt. 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 Deepak Fertilisers And Petrochemicals can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Deepak Fertilisers And Petrochemicals produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Deepak Fertilisers And Petrochemicals's impressive EBIT growth rate implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. When we consider the range of factors above, it looks like Deepak Fertilisers And Petrochemicals is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Deepak Fertilisers And Petrochemicals that you should be aware of.

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.