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. As with many other companies NATCO Pharma Limited (NSE:NATCOPHARM) makes use of debt. But is this debt a concern to shareholders?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.
What Is NATCO Pharma's Debt?
You can click the graphic below for the historical numbers, but it shows that NATCO Pharma had ₹3.59b of debt in September 2021, down from ₹4.33b, one year before. However, it does have ₹7.73b in cash offsetting this, leading to net cash of ₹4.14b.
How Healthy Is NATCO Pharma's Balance Sheet?
We can see from the most recent balance sheet that NATCO Pharma had liabilities of ₹6.58b falling due within a year, and liabilities of ₹1.65b due beyond that. Offsetting these obligations, it had cash of ₹7.73b as well as receivables valued at ₹4.76b due within 12 months. So it can boast ₹4.26b more liquid assets than total liabilities.
This surplus suggests that NATCO Pharma has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that NATCO Pharma has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that NATCO Pharma's load is not too heavy, because its EBIT was down 64% 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. During the last three years, NATCO Pharma 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.
While we empathize with investors who find debt concerning, you should keep in mind that NATCO Pharma has net cash of ₹4.14b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about NATCO Pharma's balance sheet. 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. For example, we've discovered 1 warning sign for NATCO Pharma that you should be aware of before investing here.
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.