NATCO Pharma (NSE:NATCOPHARM) Seems To Use Debt Rather Sparingly

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.' 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. As with many other companies NATCO Pharma Limited (NSE:NATCOPHARM) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first thing to do when considering how much debt a business uses is to look at 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 at March 2024 NATCO Pharma had debt of ₹3.63b, up from ₹1.74b in one year. However, its balance sheet shows it holds ₹18.5b in cash, so it actually has ₹14.9b 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 ₹9.73b falling due within a year, and liabilities of ₹804.0m due beyond that. Offsetting these obligations, it had cash of ₹18.5b as well as receivables valued at ₹12.0b due within 12 months. So it actually has ₹19.9b 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 109% over twelve months. 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 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. In the last three years, NATCO Pharma's free cash flow amounted to 50% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that NATCO Pharma has net cash of ₹14.9b, as well as more liquid assets than liabilities. And we liked the look of last year's 109% year-on-year EBIT growth. So we don't think NATCO Pharma's use of debt is risky. 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 instance, we've identified 2 warning signs for NATCO Pharma (1 doesn't sit too well with us) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com