Is Himadri Speciality Chemical (NSE:HSCL) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Himadri Speciality Chemical Limited (NSE:HSCL) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Himadri Speciality Chemical

What Is Himadri Speciality Chemical's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Himadri Speciality Chemical had ₹7.47b of debt, an increase on ₹5.05b, over one year. However, because it has a cash reserve of ₹1.38b, its net debt is less, at about ₹6.09b.

How Healthy Is Himadri Speciality Chemical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Himadri Speciality Chemical had liabilities of ₹8.41b due within 12 months and liabilities of ₹1.58b due beyond that. Offsetting this, it had ₹1.38b in cash and ₹4.76b in receivables that were due within 12 months. So it has liabilities totalling ₹3.85b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Himadri Speciality Chemical is worth ₹18.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Himadri Speciality Chemical has a debt to EBITDA ratio of 4.4 and its EBIT covered its interest expense 2.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Worse, Himadri Speciality Chemical's EBIT was down 64% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Himadri Speciality Chemical'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Himadri Speciality Chemical's free cash flow amounted to 26% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over Himadri Speciality Chemical's attempt at (not) growing its EBIT, we're certainly not enthusiastic. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, we think it's fair to say that Himadri Speciality Chemical has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Himadri Speciality Chemical (of which 1 is a bit concerning!) you should know about.

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.
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