These 4 Measures Indicate That Sanginita Chemicals (NSE:SANGINITA) Is Using Debt Reasonably Well

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Sanginita Chemicals Limited (NSE:SANGINITA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sanginita Chemicals

What Is Sanginita Chemicals's Debt?

The chart below, which you can click on for greater detail, shows that Sanginita Chemicals had ₹321.1m in debt in September 2023; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Sanginita Chemicals' Balance Sheet?

The latest balance sheet data shows that Sanginita Chemicals had liabilities of ₹403.8m due within a year, and liabilities of ₹30.8m falling due after that. Offsetting this, it had ₹159.0k in cash and ₹269.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹165.4m.

This deficit isn't so bad because Sanginita Chemicals is worth ₹487.8m, 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). 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).

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 7.2 hit our confidence in Sanginita Chemicals like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, it should be some comfort for shareholders to recall that Sanginita Chemicals actually grew its EBIT by a hefty 352%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sanginita Chemicals'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Sanginita Chemicals actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We weren't impressed with Sanginita Chemicals's interest cover, and its net debt to EBITDA made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. Considering this range of data points, we think Sanginita Chemicals is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example, we've discovered 4 warning signs for Sanginita Chemicals that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.