We Think UPL (NSE:UPL) Can Stay On Top Of Its Debt

Warren Buffett famously said, '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, UPL Limited (NSE:UPL) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 UPL

How Much Debt Does UPL Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 UPL had ₹325.5b of debt, an increase on ₹271.5b, over one year. However, because it has a cash reserve of ₹40.8b, its net debt is less, at about ₹284.7b.

How Healthy Is UPL's Balance Sheet?

We can see from the most recent balance sheet that UPL had liabilities of ₹327.2b falling due within a year, and liabilities of ₹270.8b due beyond that. On the other hand, it had cash of ₹40.8b and ₹166.7b worth of receivables due within a year. So its liabilities total ₹390.5b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₹537.1b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

UPL has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 4.1 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that UPL grew its EBIT a smooth 33% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine UPL's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, UPL's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

When it comes to the balance sheet, the standout positive for UPL was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. For example, its level of total liabilities makes us a little nervous about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about UPL's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. We've identified 1 warning sign with UPL , and understanding them should be part of your investment process.

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.