We Think Glenmark Pharmaceuticals (NSE:GLENMARK) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Glenmark Pharmaceuticals

What Is Glenmark Pharmaceuticals's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Glenmark Pharmaceuticals had debt of ₹43.5b, up from ₹36.7b in one year. However, it also had ₹14.7b in cash, and so its net debt is ₹28.8b.

A Look At Glenmark Pharmaceuticals' Liabilities

We can see from the most recent balance sheet that Glenmark Pharmaceuticals had liabilities of ₹50.5b falling due within a year, and liabilities of ₹44.9b due beyond that. On the other hand, it had cash of ₹14.7b and ₹41.0b worth of receivables due within a year. So it has liabilities totalling ₹39.6b more than its cash and near-term receivables, combined.

Glenmark Pharmaceuticals has a market capitalization of ₹190.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

While Glenmark Pharmaceuticals's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.8 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Sadly, Glenmark Pharmaceuticals's EBIT actually dropped 9.4% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Glenmark Pharmaceuticals reported free cash flow worth 13% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Both Glenmark Pharmaceuticals's conversion of EBIT to free cash flow and its EBIT growth rate were discouraging. But its not so bad at managing its debt, based on its EBITDA,. When we consider all the factors discussed, it seems to us that Glenmark Pharmaceuticals is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Glenmark Pharmaceuticals you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.