Does NATCO Pharma (NSE:NATCOPHARM) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 NATCO Pharma Limited (NSE:NATCOPHARM) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for NATCO Pharma

What Is NATCO Pharma's Debt?

As you can see below, at the end of March 2022, NATCO Pharma had ₹4.04b of debt, up from ₹2.82b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹8.00b in cash, so it actually has ₹3.96b net cash.

How Strong Is NATCO Pharma's Balance Sheet?

According to the last reported balance sheet, NATCO Pharma had liabilities of ₹7.10b due within 12 months, and liabilities of ₹1.35b due beyond 12 months. On the other hand, it had cash of ₹8.00b and ₹6.31b worth of receivables due within a year. So it can boast ₹5.85b more liquid assets than total liabilities.

This short term liquidity is a sign that NATCO Pharma could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that NATCO Pharma has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for NATCO Pharma if management cannot prevent a repeat of the 75% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 NATCO Pharma'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, a company can only pay off debt with cold hard cash, not accounting profits. NATCO Pharma 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 last three years, NATCO Pharma recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While it is always sensible to investigate a company's debt, in this case NATCO Pharma has ₹3.96b in net cash and a decent-looking balance sheet. So while NATCO Pharma does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. 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 3 warning signs for NATCO Pharma 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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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.