These 4 Measures Indicate That Southern Petrochemical Industries (NSE:SPIC) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Southern Petrochemical Industries Corporation Limited (NSE:SPIC) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See 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 ₹1.85b of debt in September 2020, down from ₹2.70b, one year before. But on the other hand it also has ₹8.58b in cash, leading to a ₹6.73b net cash position.

A Look At Southern Petrochemical Industries' Liabilities

We can see from the most recent balance sheet that Southern Petrochemical Industries had liabilities of ₹14.8b falling due within a year, and liabilities of ₹374.8m due beyond that. Offsetting these obligations, it had cash of ₹8.58b as well as receivables valued at ₹46.5m due within 12 months. So it has liabilities totalling ₹6.52b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's ₹5.44b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Southern Petrochemical Industries boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Shareholders should be aware that Southern Petrochemical Industries's EBIT was down 26% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Southern Petrochemical Industries'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 last three years, Southern Petrochemical Industries recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

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 ₹6.73b. And it impressed us with free cash flow of -₹314m, being 96% of its EBIT. So while Southern Petrochemical Industries does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. 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 .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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