Here's Why Fertilisers And Chemicals Travancore (NSE:FACT) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that The Fertilisers And Chemicals Travancore Limited (NSE:FACT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 the opportunities and risks within the IN Chemicals industry.

What Is Fertilisers And Chemicals Travancore's Net Debt?

As you can see below, at the end of September 2022, Fertilisers And Chemicals Travancore had ₹18.0b of debt, up from ₹153.0m a year ago. Click the image for more detail. However, because it has a cash reserve of ₹17.4b, its net debt is less, at about ₹595.1m.

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

The latest balance sheet data shows that Fertilisers And Chemicals Travancore had liabilities of ₹41.8b due within a year, and liabilities of ₹2.43b falling due after that. On the other hand, it had cash of ₹17.4b and ₹8.66b worth of receivables due within a year. So it has liabilities totalling ₹18.1b more than its cash and near-term receivables, combined.

Since publicly traded Fertilisers And Chemicals Travancore shares are worth a total of ₹105.1b, 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. Carrying virtually no net debt, Fertilisers And Chemicals Travancore has a very light debt load indeed.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Fertilisers And Chemicals Travancore's net debt to EBITDA ratio is very low, at 0.071, suggesting the debt is only trivial. Although with EBIT only covering interest expenses 5.2 times over, the company is truly paying for borrowing. Importantly, Fertilisers And Chemicals Travancore grew its EBIT by 50% 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 Fertilisers And Chemicals Travancore's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last three years, Fertilisers And Chemicals Travancore produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Fertilisers And Chemicals Travancore's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. 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. Over time, share prices tend to follow earnings per share, so if you're interested in Fertilisers And Chemicals Travancore, you may well want to click here to check an interactive graph of its earnings per share history.

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.