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

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. We can see that NATCO Pharma Limited (NSE:NATCOPHARM) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for NATCO Pharma

What Is NATCO Pharma's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 NATCO Pharma had debt of ₹2.39b, up from ₹832.0m in one year. But it also has ₹12.2b in cash to offset that, meaning it has ₹9.77b net cash.

How Strong Is NATCO Pharma's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NATCO Pharma had liabilities of ₹8.78b due within 12 months and liabilities of ₹822.0m due beyond that. Offsetting this, it had ₹12.2b in cash and ₹11.3b in receivables that were due within 12 months. So it actually has ₹13.8b 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.

Better yet, NATCO Pharma grew its EBIT by 182% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if NATCO Pharma can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. In the last three years, NATCO Pharma's free cash flow amounted to 43% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case NATCO Pharma has ₹9.77b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 182% over the last year. So is NATCO Pharma's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 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.