Mangalore Chemicals & Fertilizers (NSE:MANGCHEFER) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Mangalore Chemicals & Fertilizers Limited (NSE:MANGCHEFER) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Mangalore Chemicals & Fertilizers

What Is Mangalore Chemicals & Fertilizers's Net Debt?

As you can see below, Mangalore Chemicals & Fertilizers had ₹7.85b of debt at March 2021, down from ₹14.8b a year prior. However, it does have ₹4.51b in cash offsetting this, leading to net debt of about ₹3.34b.

How Strong Is Mangalore Chemicals & Fertilizers' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mangalore Chemicals & Fertilizers had liabilities of ₹12.0b due within 12 months and liabilities of ₹1.89b due beyond that. Offsetting these obligations, it had cash of ₹4.51b as well as receivables valued at ₹5.09b due within 12 months. So it has liabilities totalling ₹4.30b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Mangalore Chemicals & Fertilizers has a market capitalization of ₹10.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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).

While Mangalore Chemicals & Fertilizers has a quite reasonable net debt to EBITDA multiple of 1.6, its interest cover seems weak, at 2.0. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Importantly, Mangalore Chemicals & Fertilizers's EBIT fell a jaw-dropping 21% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Mangalore Chemicals & Fertilizers's earnings that will influence how the balance sheet holds up in the future. 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Mangalore Chemicals & Fertilizers actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Neither Mangalore Chemicals & Fertilizers's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. We think that Mangalore Chemicals & Fertilizers's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example, we've discovered 2 warning signs for Mangalore Chemicals & Fertilizers (1 is potentially serious!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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