Is Morepen Laboratories (NSE:MOREPENLAB) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Morepen Laboratories Limited (NSE:MOREPENLAB) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Morepen Laboratories

What Is Morepen Laboratories's Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Morepen Laboratories had debt of ₹1.85b, up from ₹1.33b in one year. However, it does have ₹678.9m in cash offsetting this, leading to net debt of about ₹1.17b.

A Look At Morepen Laboratories' Liabilities

The latest balance sheet data shows that Morepen Laboratories had liabilities of ₹4.04b due within a year, and liabilities of ₹300.6m falling due after that. Offsetting this, it had ₹678.9m in cash and ₹1.83b in receivables that were due within 12 months. So its liabilities total ₹1.83b more than the combination of its cash and short-term receivables.

Since publicly traded Morepen Laboratories shares are worth a total of ₹25.9b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Morepen Laboratories has a low net debt to EBITDA ratio of only 0.90. And its EBIT covers its interest expense a whopping 56.1 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, Morepen Laboratories grew its EBIT by 172% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Morepen Laboratories's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Morepen Laboratories reported free cash flow worth 5.9% 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

Morepen Laboratories'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 Morepen Laboratories 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. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Morepen Laboratories you should know about.

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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