Here's Why Alembic Pharmaceuticals (NSE:APLLTD) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Alembic Pharmaceuticals Limited (NSE:APLLTD) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Alembic Pharmaceuticals

What Is Alembic Pharmaceuticals's Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Alembic Pharmaceuticals had debt of ₹7.17b, up from ₹5.84b in one year. However, it does have ₹610.9m in cash offsetting this, leading to net debt of about ₹6.56b.

How Healthy Is Alembic Pharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that Alembic Pharmaceuticals had liabilities of ₹17.2b falling due within a year, and liabilities of ₹1.68b due beyond that. Offsetting these obligations, it had cash of ₹610.9m as well as receivables valued at ₹8.32b due within 12 months. So its liabilities total ₹9.91b more than the combination of its cash and short-term receivables.

Since publicly traded Alembic Pharmaceuticals shares are worth a total of ₹130.5b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Alembic Pharmaceuticals's net debt is only 1.0 times its EBITDA. And its EBIT covers its interest expense a whopping 15.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Alembic Pharmaceuticals's saving grace is its low debt levels, because its EBIT has tanked 68% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Alembic Pharmaceuticals 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Alembic Pharmaceuticals recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Neither Alembic Pharmaceuticals's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Alembic Pharmaceuticals is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 2 warning signs we've spotted with Alembic Pharmaceuticals .

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.