Is Alembic Pharmaceuticals (NSE:APLLTD) Using Too Much Debt?

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. Importantly, Alembic Pharmaceuticals Limited (NSE:APLLTD) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its 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 Alembic Pharmaceuticals had debt of ₹5.13b at the end of March 2024, a reduction from ₹7.22b over a year. However, because it has a cash reserve of ₹1.20b, its net debt is less, at about ₹3.93b.

How Healthy Is Alembic Pharmaceuticals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Alembic Pharmaceuticals had liabilities of ₹14.6b due within 12 months and liabilities of ₹1.72b due beyond that. Offsetting these obligations, it had cash of ₹1.20b as well as receivables valued at ₹10.7b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹4.35b.

Since publicly traded Alembic Pharmaceuticals shares are worth a total of ₹210.3b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Alembic Pharmaceuticals has a low net debt to EBITDA ratio of only 0.41. And its EBIT covers its interest expense a whopping 13.2 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Alembic Pharmaceuticals grew its EBIT by 12% last year, making its debt load easier to handle. 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 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Alembic Pharmaceuticals recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Alembic Pharmaceuticals's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Looking at the bigger picture, we think Alembic Pharmaceuticals's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 1 warning sign for Alembic Pharmaceuticals you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.