Glenmark Pharmaceuticals (NSE:GLENMARK) Takes On Some Risk With Its Use Of Debt

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.' 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. We note that Glenmark Pharmaceuticals Limited (NSE:GLENMARK) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Glenmark Pharmaceuticals

What Is Glenmark Pharmaceuticals's Debt?

As you can see below, at the end of September 2023, Glenmark Pharmaceuticals had ₹51.8b of debt, up from ₹42.4b a year ago. Click the image for more detail. On the flip side, it has ₹11.2b in cash leading to net debt of about ₹40.6b.

How Strong Is Glenmark Pharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that Glenmark Pharmaceuticals had liabilities of ₹58.4b falling due within a year, and liabilities of ₹44.3b due beyond that. On the other hand, it had cash of ₹11.2b and ₹32.0b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹59.5b.

Glenmark Pharmaceuticals has a market capitalization of ₹269.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

While Glenmark Pharmaceuticals's debt to EBITDA ratio (2.6) suggests that it uses some debt, its interest cover is very weak, at 2.5, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Importantly, Glenmark Pharmaceuticals's EBIT fell a jaw-dropping 27% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Glenmark Pharmaceuticals'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Glenmark Pharmaceuticals reported free cash flow worth 9.9% 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

We'd go so far as to say Glenmark Pharmaceuticals's EBIT growth rate was disappointing. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, we think it's fair to say that Glenmark Pharmaceuticals has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. 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 1 warning sign for Glenmark Pharmaceuticals 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.