Deepak Fertilisers And Petrochemicals (NSE:DEEPAKFERT) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Deepak Fertilisers And Petrochemicals Corporation Limited (NSE:DEEPAKFERT) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Deepak Fertilisers And Petrochemicals

How Much Debt Does Deepak Fertilisers And Petrochemicals Carry?

As you can see below, at the end of March 2023, Deepak Fertilisers And Petrochemicals had ₹37.0b of debt, up from ₹26.6b a year ago. Click the image for more detail. However, it does have ₹11.0b in cash offsetting this, leading to net debt of about ₹26.0b.

A Look At Deepak Fertilisers And Petrochemicals' Liabilities

According to the last reported balance sheet, Deepak Fertilisers And Petrochemicals had liabilities of ₹28.2b due within 12 months, and liabilities of ₹34.1b due beyond 12 months. On the other hand, it had cash of ₹11.0b and ₹17.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹33.6b.

While this might seem like a lot, it is not so bad since Deepak Fertilisers And Petrochemicals has a market capitalization of ₹77.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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

Deepak Fertilisers And Petrochemicals's net debt is sitting at a very reasonable 1.5 times its EBITDA, while its EBIT covered its interest expense just 6.4 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. But the other side of the story is that Deepak Fertilisers And Petrochemicals saw its EBIT decline by 7.1% 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 Deepak Fertilisers And Petrochemicals's ability to maintain a healthy balance sheet going forward. 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 we always check how much of that EBIT is translated into free cash flow. Over the last three years, Deepak Fertilisers And Petrochemicals recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Mulling over Deepak Fertilisers And Petrochemicals's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Once we consider all the factors above, together, it seems to us that Deepak Fertilisers And Petrochemicals's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Deepak Fertilisers And Petrochemicals has 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

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.