Here's Why Thirumalai Chemicals (NSE:TIRUMALCHM) Has A Meaningful Debt Burden

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.' 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. We note that Thirumalai Chemicals Limited (NSE:TIRUMALCHM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Thirumalai Chemicals

What Is Thirumalai Chemicals's Net Debt?

As you can see below, Thirumalai Chemicals had ₹1.71b of debt at September 2020, down from ₹1.80b a year prior. However, its balance sheet shows it holds ₹2.35b in cash, so it actually has ₹643.6m net cash.

How Strong Is Thirumalai Chemicals's Balance Sheet?

We can see from the most recent balance sheet that Thirumalai Chemicals had liabilities of ₹2.77b falling due within a year, and liabilities of ₹2.50b due beyond that. On the other hand, it had cash of ₹2.35b and ₹773.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.14b.

Given Thirumalai Chemicals has a market capitalization of ₹10.8b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Thirumalai Chemicals boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Thirumalai Chemicals's EBIT fell a jaw-dropping 85% in the last twelve months. 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 Thirumalai Chemicals 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Thirumalai Chemicals 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 last three years, Thirumalai Chemicals reported free cash flow worth 16% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While Thirumalai Chemicals does have more liabilities than liquid assets, it also has net cash of ₹643.6m. Despite its cash we think that Thirumalai Chemicals seems to struggle to grow its EBIT, so we are wary of the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Thirumalai Chemicals that you should be aware of.

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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