Here's Why Aurobindo Pharma (NSE:AUROPHARMA) Can Manage Its Debt Responsibly

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 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. As with many other companies Aurobindo Pharma Limited (NSE:AUROPHARMA) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Aurobindo Pharma

What Is Aurobindo Pharma's Net Debt?

As you can see below, at the end of March 2024, Aurobindo Pharma had ₹63.2b of debt, up from ₹48.6b a year ago. Click the image for more detail. However, it does have ₹63.3b in cash offsetting this, leading to net cash of ₹136.6m.

How Strong Is Aurobindo Pharma's Balance Sheet?

The latest balance sheet data shows that Aurobindo Pharma had liabilities of ₹122.0b due within a year, and liabilities of ₹30.2b falling due after that. Offsetting these obligations, it had cash of ₹63.3b as well as receivables valued at ₹48.3b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹40.6b.

Since publicly traded Aurobindo Pharma shares are worth a total of ₹715.8b, 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. While it does have liabilities worth noting, Aurobindo Pharma also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Aurobindo Pharma grew its EBIT by 69% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Aurobindo Pharma'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, a company can only pay off debt with cold hard cash, not accounting profits. Aurobindo Pharma 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. In the last three years, Aurobindo Pharma created free cash flow amounting to 8.4% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

We could understand if investors are concerned about Aurobindo Pharma's liabilities, but we can be reassured by the fact it has has net cash of ₹136.6m. And it impressed us with its EBIT growth of 69% over the last year. So we don't have any problem with Aurobindo Pharma's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Aurobindo Pharma you should know about.

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.

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