Is J. B. Chemicals & Pharmaceuticals (NSE:JBCHEPHARM) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that J. B. Chemicals & Pharmaceuticals Limited (NSE:JBCHEPHARM) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out the opportunities and risks within the IN Pharmaceuticals industry.

What Is J. B. Chemicals & Pharmaceuticals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 J. B. Chemicals & Pharmaceuticals had ₹3.50b of debt, an increase on ₹264.4m, over one year. However, it also had ₹1.97b in cash, and so its net debt is ₹1.53b.

How Healthy Is J. B. Chemicals & Pharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that J. B. Chemicals & Pharmaceuticals had liabilities of ₹5.56b falling due within a year, and liabilities of ₹3.35b due beyond that. On the other hand, it had cash of ₹1.97b and ₹6.48b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹469.0m.

This state of affairs indicates that J. B. Chemicals & Pharmaceuticals' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹154.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, J. B. Chemicals & Pharmaceuticals has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

J. B. Chemicals & Pharmaceuticals's net debt is only 0.25 times its EBITDA. And its EBIT easily covers its interest expense, being 35.2 times the size. So we're pretty relaxed about its super-conservative use of debt. While J. B. Chemicals & Pharmaceuticals 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 it is future earnings, more than anything, that will determine J. B. Chemicals & 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, J. B. Chemicals & Pharmaceuticals burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

J. B. Chemicals & Pharmaceuticals's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think J. B. Chemicals & Pharmaceuticals 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. 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. To that end, you should learn about the 4 warning signs we've spotted with J. B. Chemicals & Pharmaceuticals (including 1 which is a bit concerning) .

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.