Here's Why Deepak Fertilisers And Petrochemicals (NSE:DEEPAKFERT) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Deepak Fertilisers And Petrochemicals Corporation Limited (NSE:DEEPAKFERT) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Deepak Fertilisers And Petrochemicals

How Much Debt Does Deepak Fertilisers And Petrochemicals Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Deepak Fertilisers And Petrochemicals had debt of ₹30.8b, up from ₹22.9b in one year. On the flip side, it has ₹10.8b in cash leading to net debt of about ₹20.1b.

How Healthy Is Deepak Fertilisers And Petrochemicals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Deepak Fertilisers And Petrochemicals had liabilities of ₹31.2b due within 12 months and liabilities of ₹29.2b due beyond that. On the other hand, it had cash of ₹10.8b and ₹16.0b worth of receivables due within a year. So its liabilities total ₹33.6b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Deepak Fertilisers And Petrochemicals has a market capitalization of ₹94.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Deepak Fertilisers And Petrochemicals's net debt is only 0.95 times its EBITDA. And its EBIT covers its interest expense a whopping 14.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Deepak Fertilisers And Petrochemicals grew its EBIT by 141% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Deepak Fertilisers And Petrochemicals's free cash flow amounted to 28% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Deepak Fertilisers And Petrochemicals's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Deepak Fertilisers And Petrochemicals 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. 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. Be aware that Deepak Fertilisers And Petrochemicals is showing 5 warning signs in our investment analysis , and 2 of those make us uncomfortable...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.