These 4 Measures Indicate That Manali Petrochemicals (NSE:MANALIPETC) Is Using Debt Reasonably Well

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.' 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. Importantly, Manali Petrochemicals Limited (NSE:MANALIPETC) does carry debt. But is this debt a concern to shareholders?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Manali Petrochemicals

What Is Manali Petrochemicals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Manali Petrochemicals had ₹222.9m of debt, an increase on ₹66.0m, over one year. However, its balance sheet shows it holds ₹4.48b in cash, so it actually has ₹4.25b net cash.

A Look At Manali Petrochemicals' Liabilities

According to the last reported balance sheet, Manali Petrochemicals had liabilities of ₹1.63b due within 12 months, and liabilities of ₹839.5m due beyond 12 months. Offsetting these obligations, it had cash of ₹4.48b as well as receivables valued at ₹1.28b due within 12 months. So it actually has ₹3.29b more liquid assets than total liabilities.

This surplus suggests that Manali Petrochemicals is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Manali Petrochemicals boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Manali Petrochemicals's EBIT fell a jaw-dropping 65% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Manali Petrochemicals will need earnings to service that debt. 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. Manali Petrochemicals may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Manali Petrochemicals recorded free cash flow worth 74% 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.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Manali Petrochemicals has net cash of ₹4.25b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₹373m, being 74% of its EBIT. So we are not troubled with Manali Petrochemicals's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Manali Petrochemicals , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.