Laurus Labs (NSE:LAURUSLABS) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies Laurus Labs Limited (NSE:LAURUSLABS) makes use of debt. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Laurus Labs

What Is Laurus Labs's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Laurus Labs had ₹14.5b of debt, an increase on ₹10.6b, over one year. However, because it has a cash reserve of ₹484.6m, its net debt is less, at about ₹14.0b.

A Look At Laurus Labs' Liabilities

According to the last reported balance sheet, Laurus Labs had liabilities of ₹24.6b due within 12 months, and liabilities of ₹6.93b due beyond 12 months. Offsetting these obligations, it had cash of ₹484.6m as well as receivables valued at ₹13.5b due within 12 months. So it has liabilities totalling ₹17.6b more than its cash and near-term receivables, combined.

Given Laurus Labs has a market capitalization of ₹347.5b, 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.

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).

Laurus Labs's net debt is only 0.91 times its EBITDA. And its EBIT covers its interest expense a whopping 24.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Laurus Labs grew its EBIT by 253% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Laurus Labs's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Laurus Labs created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Laurus Labs's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like Laurus Labs is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. We've identified 4 warning signs with Laurus Labs (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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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