Dr. Reddy's Laboratories (NSE:DRREDDY) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Dr. Reddy's Laboratories Limited (NSE:DRREDDY) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Dr. Reddy's Laboratories

What Is Dr. Reddy's Laboratories's Net Debt?

As you can see below, Dr. Reddy's Laboratories had ₹11.2b of debt at March 2023, down from ₹30.9b a year prior. But on the other hand it also has ₹61.8b in cash, leading to a ₹50.6b net cash position.

A Look At Dr. Reddy's Laboratories' Liabilities

According to the last reported balance sheet, Dr. Reddy's Laboratories had liabilities of ₹85.8b due within 12 months, and liabilities of ₹5.02b due beyond 12 months. Offsetting this, it had ₹61.8b in cash and ₹75.8b in receivables that were due within 12 months. So it can boast ₹46.7b more liquid assets than total liabilities.

This surplus suggests that Dr. Reddy's Laboratories has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Dr. Reddy's Laboratories has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Dr. Reddy's Laboratories grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. 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 Dr. Reddy's Laboratories'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. While Dr. Reddy's Laboratories has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Dr. Reddy's Laboratories produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Dr. Reddy's Laboratories has ₹50.6b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 34% over the last year. So we don't think Dr. Reddy's Laboratories's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Dr. Reddy's Laboratories's earnings per share history for free.

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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