Here's Why Himadri Speciality Chemical (NSE:HSCL) Has A Meaningful Debt Burden

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Himadri Speciality Chemical Limited (NSE:HSCL) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Himadri Speciality Chemical

What Is Himadri Speciality Chemical's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Himadri Speciality Chemical had ₹5.88b of debt, an increase on ₹3.99b, over one year. However, because it has a cash reserve of ₹1.99b, its net debt is less, at about ₹3.89b.

How Strong Is Himadri Speciality Chemical's Balance Sheet?

We can see from the most recent balance sheet that Himadri Speciality Chemical had liabilities of ₹8.30b falling due within a year, and liabilities of ₹1.79b due beyond that. Offsetting these obligations, it had cash of ₹1.99b as well as receivables valued at ₹3.32b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹4.78b.

This deficit isn't so bad because Himadri Speciality Chemical is worth ₹18.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

While Himadri Speciality Chemical's debt to EBITDA ratio (2.9) suggests that it uses some debt, its interest cover is very weak, at 2.3, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, Himadri Speciality Chemical's EBIT was down 80% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Himadri Speciality Chemical 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Himadri Speciality Chemical recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Himadri Speciality Chemical's EBIT growth rate was disappointing. Having said that, its ability to handle its total liabilities isn't such a worry. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Himadri Speciality Chemical stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Himadri Speciality Chemical , and understanding them should be part of your investment process.

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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