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

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 Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for NATCO Pharma

What Is NATCO Pharma's Net Debt?

As you can see below, NATCO Pharma had ₹2.08b of debt at September 2024, down from ₹2.48b a year prior. But on the other hand it also has ₹24.6b in cash, leading to a ₹22.6b net cash position.

How Healthy Is NATCO Pharma's Balance Sheet?

The latest balance sheet data shows that NATCO Pharma had liabilities of ₹10.1b due within a year, and liabilities of ₹792.0m falling due after that. Offsetting this, it had ₹24.6b in cash and ₹14.5b in receivables that were due within 12 months. So it actually has ₹28.2b more liquid assets than total liabilities.

This excess liquidity suggests that NATCO Pharma is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, NATCO Pharma boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, NATCO Pharma grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case NATCO Pharma has ₹22.6b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 34% over the last year. So we don't think NATCO Pharma's use of debt is risky. 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. For example NATCO Pharma has 2 warning signs (and 1 which can't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.