Is NATCO Pharma (NSE:NATCOPHARM) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, NATCO Pharma Limited (NSE:NATCOPHARM) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for NATCO Pharma

How Much Debt Does NATCO Pharma Carry?

You can click the graphic below for the historical numbers, but it shows that NATCO Pharma had ₹1.65b of debt in March 2023, down from ₹4.21b, one year before. However, it does have ₹11.6b in cash offsetting this, leading to net cash of ₹9.97b.

A Look At NATCO Pharma's Liabilities

We can see from the most recent balance sheet that NATCO Pharma had liabilities of ₹6.83b falling due within a year, and liabilities of ₹1.01b due beyond that. Offsetting these obligations, it had cash of ₹11.6b as well as receivables valued at ₹8.66b due within 12 months. So it actually has ₹12.4b 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.

Even more impressive was the fact that NATCO Pharma grew its EBIT by 546% over twelve months. That boost will make it even easier to pay down debt going forward. 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. While NATCO Pharma has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, NATCO Pharma recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that NATCO Pharma has net cash of ₹9.97b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 546% over the last year. So is NATCO Pharma's debt a risk? It doesn't seem so to us. 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. 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.