Is Aurobindo Pharma (NSE:AUROPHARMA) A Risky Investment?

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 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, Aurobindo Pharma Limited (NSE:AUROPHARMA) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Aurobindo Pharma

What Is Aurobindo Pharma's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Aurobindo Pharma had ₹48.6b of debt, an increase on ₹23.7b, over one year. However, it does have ₹62.4b in cash offsetting this, leading to net cash of ₹13.7b.

A Look At Aurobindo Pharma's Liabilities

Zooming in on the latest balance sheet data, we can see that Aurobindo Pharma had liabilities of ₹114.9b due within 12 months and liabilities of ₹15.4b due beyond that. Offsetting this, it had ₹62.4b in cash and ₹44.8b in receivables that were due within 12 months. So its liabilities total ₹23.2b more than the combination of its cash and short-term receivables.

Since publicly traded Aurobindo Pharma shares are worth a total of ₹399.4b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Aurobindo Pharma boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Aurobindo Pharma's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Aurobindo Pharma 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Aurobindo Pharma has ₹13.7b in net cash. So we are not troubled with Aurobindo Pharma's debt use. 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. Case in point: We've spotted 2 warning signs for Aurobindo Pharma you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.