Supreme Petrochem (NSE:SPLPETRO) Seems To Use Debt Quite Sensibly

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. Importantly, Supreme Petrochem Limited (NSE:SPLPETRO) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Supreme Petrochem

How Much Debt Does Supreme Petrochem Carry?

The image below, which you can click on for greater detail, shows that Supreme Petrochem had debt of ₹270.0m at the end of September 2022, a reduction from ₹393.7m over a year. However, its balance sheet shows it holds ₹9.05b in cash, so it actually has ₹8.78b net cash.

How Strong Is Supreme Petrochem's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Supreme Petrochem had liabilities of ₹6.39b due within 12 months and liabilities of ₹477.5m due beyond that. Offsetting these obligations, it had cash of ₹9.05b as well as receivables valued at ₹3.65b due within 12 months. So it can boast ₹5.83b more liquid assets than total liabilities.

This surplus suggests that Supreme Petrochem has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Supreme Petrochem boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Supreme Petrochem's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is Supreme Petrochem'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. Supreme Petrochem 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, Supreme Petrochem recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Supreme Petrochem has ₹8.78b in net cash and a decent-looking balance sheet. So we don't have any problem with Supreme Petrochem's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Supreme Petrochem is showing 1 warning sign in our investment analysis , you should know about...

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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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.