These 4 Measures Indicate That Dr. Reddy's Laboratories (NSE:DRREDDY) Is Using Debt Reasonably Well

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.' 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 Dr. Reddy's Laboratories Limited (NSE:DRREDDY) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Dr. Reddy's Laboratories

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

The image below, which you can click on for greater detail, shows that Dr. Reddy's Laboratories had debt of ₹14.6b at the end of September 2022, a reduction from ₹27.2b over a year. But it also has ₹27.6b in cash to offset that, meaning it has ₹13.0b net cash.

A Look At Dr. Reddy's Laboratories' Liabilities

We can see from the most recent balance sheet that Dr. Reddy's Laboratories had liabilities of ₹80.0b falling due within a year, and liabilities of ₹4.72b due beyond that. Offsetting these obligations, it had cash of ₹27.6b as well as receivables valued at ₹80.1b due within 12 months. So it actually has ₹22.9b 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.

Also positive, Dr. Reddy's Laboratories grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Looking at the most recent three years, Dr. Reddy's Laboratories recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Dr. Reddy's Laboratories has ₹13.0b in net cash and a decent-looking balance sheet. And we liked the look of last year's 24% year-on-year EBIT growth. So we don't think Dr. Reddy's Laboratories's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Dr. Reddy's Laboratories, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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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.