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

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.' 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, Eris Lifesciences Limited (NSE:ERIS) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Eris Lifesciences

What Is Eris Lifesciences's Debt?

As you can see below, at the end of March 2024, Eris Lifesciences had ₹27.4b of debt, up from ₹9.07b a year ago. Click the image for more detail. On the flip side, it has ₹14.0b in cash leading to net debt of about ₹13.3b.

How Strong Is Eris Lifesciences' Balance Sheet?

We can see from the most recent balance sheet that Eris Lifesciences had liabilities of ₹25.3b falling due within a year, and liabilities of ₹12.9b due beyond that. On the other hand, it had cash of ₹14.0b and ₹4.28b worth of receivables due within a year. So its liabilities total ₹20.0b more than the combination of its cash and short-term receivables.

Of course, Eris Lifesciences has a market capitalization of ₹152.5b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Eris Lifesciences's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 4.2 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Also relevant is that Eris Lifesciences has grown its EBIT by a very respectable 22% in the last year, thus enhancing its ability to pay down debt. 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 Eris Lifesciences 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.

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. In the last three years, Eris Lifesciences created free cash flow amounting to 4.8% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

When it comes to the balance sheet, the standout positive for Eris Lifesciences was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. To be specific, it seems about as good at converting EBIT to free cash flow as wet socks are at keeping your feet warm. Looking at all this data makes us feel a little cautious about Eris Lifesciences's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Eris Lifesciences (of which 1 is potentially serious!) you should know about.

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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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.

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