NATCO Pharma (NSE:NATCOPHARM) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, NATCO Pharma Limited (NSE:NATCOPHARM) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See 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 ₹3.14b of debt in March 2020, down from ₹3.86b, one year before. But it also has ₹9.54b in cash to offset that, meaning it has ₹6.39b net cash.

How Strong Is NATCO Pharma's Balance Sheet?

We can see from the most recent balance sheet that NATCO Pharma had liabilities of ₹6.85b falling due within a year, and liabilities of ₹1.18b due beyond that. Offsetting these obligations, it had cash of ₹9.54b as well as receivables valued at ₹6.33b due within 12 months. So it can boast ₹7.84b 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!

The modesty of its debt load may become crucial for NATCO Pharma if management cannot prevent a repeat of the 33% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the last three years, NATCO Pharma reported free cash flow worth 6.4% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to investigate a company's debt, in this case NATCO Pharma has ₹6.39b in net cash and a decent-looking balance sheet. So we don't have any problem with NATCO Pharma's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - NATCO Pharma has 2 warning signs we think you should be aware of.

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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