Is Southern Petrochemical Industries (NSE:SPIC) Using Too Much Debt?

Warren Buffett famously said, '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 can see that Southern Petrochemical Industries Corporation Limited (NSE:SPIC) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Southern Petrochemical Industries

How Much Debt Does Southern Petrochemical Industries Carry?

You can click the graphic below for the historical numbers, but it shows that Southern Petrochemical Industries had ₹1.19b of debt in March 2021, down from ₹4.08b, one year before. However, its balance sheet shows it holds ₹3.37b in cash, so it actually has ₹2.19b net cash.

How Healthy Is Southern Petrochemical Industries' Balance Sheet?

We can see from the most recent balance sheet that Southern Petrochemical Industries had liabilities of ₹11.6b falling due within a year, and liabilities of ₹321.2m due beyond that. Offsetting these obligations, it had cash of ₹3.37b as well as receivables valued at ₹71.9m due within 12 months. So it has liabilities totalling ₹8.52b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₹13.2b, 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. Despite its noteworthy liabilities, Southern Petrochemical Industries boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Southern Petrochemical Industries's EBIT was down 55% last year. 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 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Southern Petrochemical Industries 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, Southern Petrochemical Industries recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

Although Southern Petrochemical Industries's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹2.19b. And it impressed us with free cash flow of ₹1.5b, being 68% of its EBIT. So while Southern Petrochemical Industries does not have a great balance sheet, it's certainly not too bad. 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. To that end, you should be aware of the 2 warning signs we've spotted with Southern Petrochemical Industries .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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