These 4 Measures Indicate That Deepak Fertilisers And Petrochemicals (NSE:DEEPAKFERT) Is Using Debt Extensively

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.' 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. As with many other companies Deepak Fertilisers And Petrochemicals Corporation Limited (NSE:DEEPAKFERT) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for Deepak Fertilisers And Petrochemicals

What Is Deepak Fertilisers And Petrochemicals's Net Debt?

The image below, which you can click on for greater detail, shows that Deepak Fertilisers And Petrochemicals had debt of ₹37.8b at the end of September 2024, a reduction from ₹40.8b over a year. However, it does have ₹4.96b in cash offsetting this, leading to net debt of about ₹32.8b.

How Strong 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 ₹37.8b due within 12 months and liabilities of ₹27.5b due beyond that. On the other hand, it had cash of ₹4.96b and ₹17.0b worth of receivables due within a year. So it has liabilities totalling ₹43.3b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Deepak Fertilisers And Petrochemicals has a market capitalization of ₹138.2b, 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 has net debt worth 1.8 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.9 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Deepak Fertilisers And Petrochemicals grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Deepak Fertilisers And Petrochemicals recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Deepak Fertilisers And Petrochemicals's conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. We think that Deepak Fertilisers And Petrochemicals's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 we think you should be aware of.

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.