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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Ipca Laboratories Limited (NSE:IPCALAB) does use debt in its business. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Ipca Laboratories's Debt?
You can click the graphic below for the historical numbers, but it shows that Ipca Laboratories had ₹2.65b of debt in March 2021, down from ₹5.01b, one year before. But on the other hand it also has ₹7.58b in cash, leading to a ₹4.92b net cash position.
How Healthy Is Ipca Laboratories' Balance Sheet?
We can see from the most recent balance sheet that Ipca Laboratories had liabilities of ₹11.3b falling due within a year, and liabilities of ₹2.19b due beyond that. Offsetting these obligations, it had cash of ₹7.58b as well as receivables valued at ₹10.1b due within 12 months. So it actually has ₹4.19b more liquid assets than total liabilities.
Having regard to Ipca Laboratories' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹306.0b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Ipca Laboratories has more cash than debt is arguably a good indication that it can manage its debt safely.
While Ipca Laboratories doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ipca Laboratories 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Ipca Laboratories may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Ipca Laboratories recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that Ipca Laboratories has net cash of ₹4.92b, as well as more liquid assets than liabilities. So we are not troubled with Ipca Laboratories's debt use. There's no doubt that we learn most about debt from the balance sheet. 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 1 warning sign for Ipca Laboratories you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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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