Stock Analysis

We Think Alembic Pharmaceuticals (NSE:APLLTD) Is Taking Some Risk With Its Debt

NSEI:APLLTD
Source: Shutterstock

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Alembic Pharmaceuticals Limited (NSE:APLLTD) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Alembic Pharmaceuticals

How Much Debt Does Alembic Pharmaceuticals Carry?

As you can see below, at the end of March 2022, Alembic Pharmaceuticals had ₹6.30b of debt, up from ₹5.00b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹694.3m, its net debt is less, at about ₹5.61b.

debt-equity-history-analysis
NSEI:APLLTD Debt to Equity History May 5th 2022

How Strong Is Alembic Pharmaceuticals' Balance Sheet?

The latest balance sheet data shows that Alembic Pharmaceuticals had liabilities of ₹17.2b due within a year, and liabilities of ₹1.68b falling due after that. Offsetting these obligations, it had cash of ₹694.3m as well as receivables valued at ₹8.32b due within 12 months. So its liabilities total ₹9.83b more than the combination of its cash and short-term receivables.

Given Alembic Pharmaceuticals has a market capitalization of ₹144.2b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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 has a low net debt to EBITDA ratio of only 0.64. And its EBIT easily covers its interest expense, being 33.1 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Alembic Pharmaceuticals's saving grace is its low debt levels, because its EBIT has tanked 55% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Alembic Pharmaceuticals's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Alembic Pharmaceuticals's free cash flow amounted to 22% of its EBIT, less 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 its interest cover tells a very different story, and suggests some resilience. We think that Alembic Pharmaceuticals's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example - Alembic Pharmaceuticals has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Valuation is complex, but we're helping make it simple.

Find out whether Alembic Pharmaceuticals is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.