Here's Why Eris Lifesciences (NSE:ERIS) Can Manage Its Debt Responsibly

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.' 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 the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Eris Lifesciences

How Much Debt Does Eris Lifesciences Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Eris Lifesciences had debt of ₹27.0b, up from ₹7.86b in one year. However, because it has a cash reserve of ₹2.43b, its net debt is less, at about ₹24.5b.

A Look At Eris Lifesciences' Liabilities

According to the last reported balance sheet, Eris Lifesciences had liabilities of ₹12.3b due within 12 months, and liabilities of ₹26.1b due beyond 12 months. Offsetting this, it had ₹2.43b in cash and ₹5.68b in receivables that were due within 12 months. So its liabilities total ₹30.3b more than the combination of its cash and short-term receivables.

Given Eris Lifesciences has a market capitalization of ₹186.3b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Eris Lifesciences's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 3.6 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. On the other hand, Eris Lifesciences grew its EBIT by 27% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Eris Lifesciences can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Eris Lifesciences's free cash flow amounted to 21% of its EBIT, less than we'd expect. That's not great, when it comes to paying 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. For example, its interest cover makes us a little nervous about its debt. Considering this range of data points, we think Eris Lifesciences is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example, we've discovered 2 warning signs for Eris Lifesciences that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.