Fertilisers and Chemicals Travancore (NSE:FACT) Takes On Some Risk With Its Use Of Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that The Fertilisers and Chemicals Travancore Limited (NSE:FACT) does use debt in its business. But should shareholders be worried about its use of debt?

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When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Fertilisers and Chemicals Travancore's Net Debt?

The chart below, which you can click on for greater detail, shows that Fertilisers and Chemicals Travancore had ₹18.1b in debt in September 2024; about the same as the year before. But on the other hand it also has ₹26.1b in cash, leading to a ₹7.98b net cash position.

How Strong Is Fertilisers and Chemicals Travancore's Balance Sheet?

According to the last reported balance sheet, Fertilisers and Chemicals Travancore had liabilities of ₹41.8b due within 12 months, and liabilities of ₹2.08b due beyond 12 months. Offsetting these obligations, it had cash of ₹26.1b as well as receivables valued at ₹2.88b due within 12 months. So its liabilities total ₹15.0b more than the combination of its cash and short-term receivables.

Since publicly traded Fertilisers and Chemicals Travancore shares are worth a total of ₹424.8b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Fertilisers and Chemicals Travancore boasts net cash, so it's fair to say it does not have a heavy debt load!

View our latest analysis for Fertilisers and Chemicals Travancore

Shareholders should be aware that Fertilisers and Chemicals Travancore's EBIT was down 97% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. 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. While Fertilisers and Chemicals Travancore has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Fertilisers and Chemicals Travancore recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Fertilisers and Chemicals Travancore has ₹7.98b in net cash. So while Fertilisers and Chemicals Travancore does not have a great balance sheet, it's certainly not too bad. 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. Case in point: We've spotted 1 warning sign for Fertilisers and Chemicals Travancore you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.