We Think Mangalam Drugs & Organics (NSE:MANGALAM) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Mangalam Drugs & Organics Limited (NSE:MANGALAM) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Mangalam Drugs & Organics

What Is Mangalam Drugs & Organics's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Mangalam Drugs & Organics had debt of ₹681.4m, up from ₹490.5m in one year. However, because it has a cash reserve of ₹31.0m, its net debt is less, at about ₹650.4m.

How Strong Is Mangalam Drugs & Organics' Balance Sheet?

We can see from the most recent balance sheet that Mangalam Drugs & Organics had liabilities of ₹1.46b falling due within a year, and liabilities of ₹455.2m due beyond that. On the other hand, it had cash of ₹31.0m and ₹513.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.37b.

This deficit is considerable relative to its market capitalization of ₹2.18b, so it does suggest shareholders should keep an eye on Mangalam Drugs & Organics' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

While Mangalam Drugs & Organics's low debt to EBITDA ratio of 1.5 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.1 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably Mangalam Drugs & Organics's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Mangalam Drugs & Organics will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. In the last three years, Mangalam Drugs & Organics's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Both Mangalam Drugs & Organics's level of total liabilities and its conversion of EBIT to free cash flow were discouraging. But its not so bad at managing its debt, based on its EBITDA,. We think that Mangalam Drugs & Organics's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Mangalam Drugs & Organics (1 can't be ignored) you should be aware of.

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.