Is NATCO Pharma (NSE:NATCOPHARM) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. 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 Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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. 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

What Is NATCO Pharma's Net Debt?

The image below, which you can click on for greater detail, shows that NATCO Pharma had debt of ₹2.01b at the end of September 2024, a reduction from ₹2.39b over a year. However, it does have ₹24.6b in cash offsetting this, leading to net cash of ₹22.6b.

How Healthy Is NATCO Pharma's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NATCO Pharma had liabilities of ₹10.1b due within 12 months and liabilities of ₹792.0m due beyond that. Offsetting these obligations, it had cash of ₹24.6b as well as receivables valued at ₹14.5b due within 12 months. So it can boast ₹28.2b 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. 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 72% 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 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.

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 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that NATCO Pharma has net cash of ₹22.6b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 72% 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. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with NATCO Pharma (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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.