Is Dr. Reddy's Laboratories (NSE:DRREDDY) Using Too Much 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.' 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. As with many other companies Dr. Reddy's Laboratories Limited (NSE:DRREDDY) 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Dr. Reddy's Laboratories

How Much Debt Does Dr. Reddy's Laboratories Carry?

You can click the graphic below for the historical numbers, but it shows that Dr. Reddy's Laboratories had ₹15.3b of debt in December 2022, down from ₹25.1b, one year before. But on the other hand it also has ₹48.5b in cash, leading to a ₹33.2b net cash position.

How Strong Is Dr. Reddy's Laboratories' Balance Sheet?

According to the last reported balance sheet, Dr. Reddy's Laboratories had liabilities of ₹84.4b due within 12 months, and liabilities of ₹4.64b due beyond 12 months. Offsetting these obligations, it had cash of ₹48.5b as well as receivables valued at ₹77.3b due within 12 months. So it actually has ₹36.8b more liquid assets than total liabilities.

This short term liquidity is a sign that Dr. Reddy's Laboratories could probably pay off its debt with ease, as its balance sheet is far from stretched. 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.

Also positive, Dr. Reddy's Laboratories grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Over the most recent three years, Dr. Reddy's Laboratories recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 ₹33.2b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 22% 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.

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.