Ajanta Pharma (NSE:AJANTPHARM) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Ajanta Pharma Limited (NSE:AJANTPHARM) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Ajanta Pharma

What Is Ajanta Pharma's Net Debt?

As you can see below, at the end of September 2021, Ajanta Pharma had ₹269.1m of debt, up from ₹244.4m a year ago. Click the image for more detail. But on the other hand it also has ₹5.69b in cash, leading to a ₹5.42b net cash position.

A Look At Ajanta Pharma's Liabilities

We can see from the most recent balance sheet that Ajanta Pharma had liabilities of ₹5.63b falling due within a year, and liabilities of ₹1.41b due beyond that. Offsetting this, it had ₹5.69b in cash and ₹8.28b in receivables that were due within 12 months. So it actually has ₹6.93b more liquid assets than total liabilities.

This short term liquidity is a sign that Ajanta Pharma could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Ajanta Pharma boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Ajanta Pharma grew its EBIT by 11% last year, making its debt load easier to handle. 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 Ajanta Pharma can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ajanta Pharma 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. In the last three years, Ajanta Pharma's free cash flow amounted to 42% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Ajanta Pharma has ₹5.42b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 11% in the last twelve months. So is Ajanta Pharma's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Ajanta Pharma that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.