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

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Ajanta Pharma Limited (NSE:AJANTPHARM) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ajanta Pharma

How Much Debt Does Ajanta Pharma Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Ajanta Pharma had ₹394.7m of debt, an increase on ₹345.2m, over one year. But it also has ₹8.40b in cash to offset that, meaning it has ₹8.01b net cash.

How Strong Is Ajanta Pharma's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ajanta Pharma had liabilities of ₹11.4b due within 12 months and liabilities of ₹1.52b due beyond that. Offsetting this, it had ₹8.40b in cash and ₹11.2b in receivables that were due within 12 months. So it actually has ₹6.69b 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. Simply put, the fact that Ajanta Pharma has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Ajanta Pharma's EBIT dived 13%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Ajanta Pharma's ability to maintain a healthy balance sheet going forward. 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. Over the most recent three years, Ajanta Pharma recorded free cash flow worth 60% 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 we empathize with investors who find debt concerning, you should keep in mind that Ajanta Pharma has net cash of ₹8.01b, as well as more liquid assets than liabilities. So we don't have any problem with Ajanta Pharma's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Ajanta Pharma you should know about.

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.