Eris Lifesciences (NSE:ERIS) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Eris Lifesciences Limited (NSE:ERIS) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Eris Lifesciences

What Is Eris Lifesciences's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Eris Lifesciences had ₹7.86b of debt, an increase on ₹2.23b, over one year. However, it does have ₹1.91b in cash offsetting this, leading to net debt of about ₹5.95b.

How Strong Is Eris Lifesciences' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Eris Lifesciences had liabilities of ₹4.97b due within 12 months and liabilities of ₹9.50b due beyond that. Offsetting this, it had ₹1.91b in cash and ₹3.55b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹9.02b.

Given Eris Lifesciences has a market capitalization of ₹124.1b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Eris Lifesciences's net debt is only 1.00 times its EBITDA. And its EBIT covers its interest expense a whopping 10.7 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Eris Lifesciences grew its EBIT at 11% over the last year, further increasing its ability to manage 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 Eris Lifesciences's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Eris Lifesciences reported free cash flow worth 9.1% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

When it comes to the balance sheet, the standout positive for Eris Lifesciences was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Eris Lifesciences is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. 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 2 warning signs for Eris Lifesciences you should know about.

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.