Solara Active Pharma Sciences (NSE:SOLARA) Is Making Moderate Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Solara Active Pharma Sciences Limited (NSE:SOLARA) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Solara Active Pharma Sciences

What Is Solara Active Pharma Sciences's Net Debt?

As you can see below, at the end of March 2022, Solara Active Pharma Sciences had ₹10.2b of debt, up from ₹6.07b a year ago. Click the image for more detail. However, it does have ₹472.5m in cash offsetting this, leading to net debt of about ₹9.77b.

How Healthy Is Solara Active Pharma Sciences' Balance Sheet?

According to the last reported balance sheet, Solara Active Pharma Sciences had liabilities of ₹10.7b due within 12 months, and liabilities of ₹3.54b due beyond 12 months. Offsetting these obligations, it had cash of ₹472.5m as well as receivables valued at ₹5.51b due within 12 months. So it has liabilities totalling ₹8.27b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₹12.6b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Solara Active Pharma Sciences can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Solara Active Pharma Sciences had a loss before interest and tax, and actually shrunk its revenue by 22%, to ₹13b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Solara Active Pharma Sciences's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at ₹324m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled ₹4.5b in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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 instance, we've identified 2 warning signs for Solara Active Pharma Sciences (1 shouldn't be ignored) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.