These 4 Measures Indicate That Vinati Organics (NSE:VINATIORGA) Is Using Debt Reasonably Well

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.' 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 Vinati Organics Limited (NSE:VINATIORGA) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Vinati Organics

What Is Vinati Organics's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Vinati Organics had ₹184.0m of debt, an increase on ₹20.2m, over one year. On the flip side, it has ₹44.1m in cash leading to net debt of about ₹139.9m.

A Look At Vinati Organics' Liabilities

We can see from the most recent balance sheet that Vinati Organics had liabilities of ₹1.67b falling due within a year, and liabilities of ₹944.8m due beyond that. Offsetting these obligations, it had cash of ₹44.1m as well as receivables valued at ₹4.76b due within 12 months. So it actually has ₹2.19b more liquid assets than total liabilities.

Having regard to Vinati Organics' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹204.7b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Vinati Organics has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Vinati Organics has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.032 and EBIT of 2k times the interest expense. So relative to past earnings, the debt load seems trivial. Another good sign is that Vinati Organics has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Vinati Organics 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Vinati Organics created free cash flow amounting to 18% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Happily, Vinati Organics's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Zooming out, Vinati Organics seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Vinati Organics you should be aware of.

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.