Is Alkem Laboratories (NSE:ALKEM) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Alkem Laboratories Limited (NSE:ALKEM) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Alkem Laboratories

What Is Alkem Laboratories's Net Debt?

As you can see below, Alkem Laboratories had ₹12.4b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has ₹22.9b in cash to offset that, meaning it has ₹10.5b net cash.

How Strong Is Alkem Laboratories' Balance Sheet?

We can see from the most recent balance sheet that Alkem Laboratories had liabilities of ₹41.8b falling due within a year, and liabilities of ₹10.3b due beyond that. Offsetting these obligations, it had cash of ₹22.9b as well as receivables valued at ₹25.1b due within 12 months. So it has liabilities totalling ₹4.05b 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 ₹652.1b 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.

Also positive, Alkem Laboratories grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Alkem Laboratories 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, Alkem Laboratories recorded free cash flow worth 74% 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 look at a company's total liabilities, it is very reassuring that Alkem Laboratories has ₹10.5b in net cash. And it impressed us with its EBIT growth of 28% over the last year. So is Alkem Laboratories's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Alkem Laboratories .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.