Is Krishana Phoschem (NSE:KRISHANA) Using Too Much 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.' 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. As with many other companies Krishana Phoschem Limited (NSE:KRISHANA) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Krishana Phoschem

What Is Krishana Phoschem's Net Debt?

The chart below, which you can click on for greater detail, shows that Krishana Phoschem had ₹294.6m in debt in September 2020; about the same as the year before. However, it does have ₹24.7m in cash offsetting this, leading to net debt of about ₹269.9m.

How Healthy Is Krishana Phoschem's Balance Sheet?

According to the last reported balance sheet, Krishana Phoschem had liabilities of ₹426.2m due within 12 months, and liabilities of ₹165.9m due beyond 12 months. On the other hand, it had cash of ₹24.7m and ₹623.1m worth of receivables due within a year. So it can boast ₹55.7m more liquid assets than total liabilities.

This surplus suggests that Krishana Phoschem has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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.

Krishana Phoschem's net debt is only 0.76 times its EBITDA. And its EBIT covers its interest expense a whopping 10.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Krishana Phoschem has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. 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 Krishana Phoschem 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Krishana Phoschem recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Krishana Phoschem's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its interest cover is also very heartening. Zooming out, Krishana Phoschem 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Krishana Phoschem that you should be aware of before investing here.

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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