Does Southern Petrochemical Industries (NSE:SPIC) Have A Healthy 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Southern Petrochemical Industries Corporation Limited (NSE:SPIC) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Southern Petrochemical Industries

What Is Southern Petrochemical Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Southern Petrochemical Industries had ₹2.49b of debt, an increase on ₹1.04b, over one year. However, it also had ₹2.48b in cash, and so its net debt is ₹15.8m.

How Healthy Is Southern Petrochemical Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Southern Petrochemical Industries had liabilities of ₹14.5b due within 12 months and liabilities of ₹381.8m due beyond that. On the other hand, it had cash of ₹2.48b and ₹40.9m worth of receivables due within a year. So it has liabilities totalling ₹12.4b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₹14.3b, so it does suggest shareholders should keep an eye on Southern Petrochemical Industries' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. But either way, Southern Petrochemical Industries has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Southern Petrochemical Industries has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.006 and EBIT of 21.8 times the interest expense. So relative to past earnings, the debt load seems trivial. Even more impressive was the fact that Southern Petrochemical Industries grew its EBIT by 100% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Southern Petrochemical Industries 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Southern Petrochemical Industries burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Southern Petrochemical Industries is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Southern Petrochemical Industries's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Southern Petrochemical Industries is showing 3 warning signs in our investment analysis , and 2 of those can't be ignored...

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.