These 4 Measures Indicate That Sumitomo Chemical India (NSE:SUMICHEM) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Sumitomo Chemical India Limited (NSE:SUMICHEM) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Sumitomo Chemical India

How Much Debt Does Sumitomo Chemical India Carry?

As you can see below, Sumitomo Chemical India had ₹326.4m of debt at March 2021, down from ₹355.8m a year prior. However, it does have ₹5.32b in cash offsetting this, leading to net cash of ₹5.00b.

A Look At Sumitomo Chemical India's Liabilities

Zooming in on the latest balance sheet data, we can see that Sumitomo Chemical India had liabilities of ₹10.8b due within 12 months and liabilities of ₹495.8m due beyond that. Offsetting these obligations, it had cash of ₹5.32b as well as receivables valued at ₹8.67b due within 12 months. So it actually has ₹2.70b more liquid assets than total liabilities.

This state of affairs indicates that Sumitomo Chemical India's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹210.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Sumitomo Chemical India has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Sumitomo Chemical India has boosted its EBIT by 46%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sumitomo Chemical India can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sumitomo Chemical India has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Sumitomo Chemical India recorded free cash flow worth 78% 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

While it is always sensible to investigate a company's debt, in this case Sumitomo Chemical India has ₹5.00b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 46% over the last year. So we don't think Sumitomo Chemical India's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Sumitomo Chemical India you should be aware of.

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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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.
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