Fertilisers And Chemicals Travancore (NSE:FACT) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that The Fertilisers And Chemicals Travancore Limited (NSE:FACT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Fertilisers And Chemicals Travancore

What Is Fertilisers And Chemicals Travancore's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Fertilisers And Chemicals Travancore had ₹18.3b of debt, an increase on ₹465.9m, over one year. However, because it has a cash reserve of ₹17.4b, its net debt is less, at about ₹917.3m.

How Healthy Is Fertilisers And Chemicals Travancore's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fertilisers And Chemicals Travancore had liabilities of ₹41.8b due within 12 months and liabilities of ₹2.43b due beyond that. Offsetting these obligations, it had cash of ₹17.4b as well as receivables valued at ₹8.66b due within 12 months. So its liabilities total ₹18.1b more than the combination of its cash and short-term receivables.

Given Fertilisers And Chemicals Travancore has a market capitalization of ₹149.6b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Fertilisers And Chemicals Travancore has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt at just 0.094 times EBITDA, it seems Fertilisers And Chemicals Travancore only uses a little bit of leverage. Although with EBIT only covering interest expenses 6.1 times over, the company is truly paying for borrowing. Better yet, Fertilisers And Chemicals Travancore grew its EBIT by 105% 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 you can't view debt in total isolation; since Fertilisers And Chemicals Travancore 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 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. Over the most recent three years, Fertilisers And Chemicals Travancore recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Fertilisers And Chemicals Travancore'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 net debt to EBITDA is also very heartening. Zooming out, Fertilisers And Chemicals Travancore seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Fertilisers And Chemicals Travancore you should know about.

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.