These 4 Measures Indicate That Ajanta Pharma (NSE:AJANTPHARM) Is Using Debt Reasonably Well

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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 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 2022, Ajanta Pharma had ₹284.8m of debt, up from ₹269.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹6.15b in cash, so it actually has ₹5.86b net cash.

How Strong Is Ajanta Pharma's Balance Sheet?

The latest balance sheet data shows that Ajanta Pharma had liabilities of ₹7.05b due within a year, and liabilities of ₹1.40b falling due after that. Offsetting these obligations, it had cash of ₹6.15b as well as receivables valued at ₹11.9b due within 12 months. So it actually has ₹9.59b 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 15%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 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. Ajanta Pharma may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Ajanta Pharma recorded free cash flow worth 54% 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 it is always sensible to investigate a company's debt, in this case Ajanta Pharma has ₹5.86b in net cash and a decent-looking balance sheet. 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.