Does Shilpa Medicare (NSE:SHILPAMED) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Shilpa Medicare Limited (NSE:SHILPAMED) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shilpa Medicare

How Much Debt Does Shilpa Medicare Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Shilpa Medicare had debt of ₹6.10b, up from ₹2.26b in one year. However, it does have ₹2.10b in cash offsetting this, leading to net debt of about ₹4.00b.

How Strong Is Shilpa Medicare's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shilpa Medicare had liabilities of ₹5.47b due within 12 months and liabilities of ₹4.87b due beyond that. On the other hand, it had cash of ₹2.10b and ₹3.18b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹5.07b.

Given Shilpa Medicare has a market capitalization of ₹34.4b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shilpa Medicare's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 23.6 times its interest expense, implies the debt load is as light as a peacock feather. On top of that, Shilpa Medicare grew its EBIT by 75% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shilpa Medicare 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Shilpa Medicare burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Shilpa Medicare is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the elements mentioned above, it seems to us that Shilpa Medicare is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Shilpa Medicare you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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