Does Alkem Laboratories (NSE:ALKEM) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Alkem Laboratories Limited (NSE:ALKEM) 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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Alkem Laboratories

What Is Alkem Laboratories's Net Debt?

As you can see below, at the end of March 2022, Alkem Laboratories had ₹25.8b of debt, up from ₹17.0b a year ago. Click the image for more detail. However, it does have ₹27.2b in cash offsetting this, leading to net cash of ₹1.38b.

How Strong Is Alkem Laboratories' Balance Sheet?

We can see from the most recent balance sheet that Alkem Laboratories had liabilities of ₹48.1b falling due within a year, and liabilities of ₹4.17b due beyond that. On the other hand, it had cash of ₹27.2b and ₹20.8b worth of receivables due within a year. So it has liabilities totalling ₹4.26b more than its cash and near-term receivables, combined.

This state of affairs indicates that Alkem Laboratories' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹358.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Alkem Laboratories also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Alkem Laboratories has increased its EBIT by 4.4% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Alkem Laboratories 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 Alkem Laboratories 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, Alkem Laboratories's free cash flow amounted to 45% 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 look at a company's total liabilities, it is very reassuring that Alkem Laboratories has ₹1.38b in net cash. And it also grew its EBIT by 4.4% over the last year. So we are not troubled with Alkem Laboratories's debt use. 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. Case in point: We've spotted 2 warning signs for Alkem Laboratories you should be aware of.

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.