Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Suven Pharmaceuticals Limited (NSE:SUVENPHAR) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.
What Is Suven Pharmaceuticals's Net Debt?
As you can see below, Suven Pharmaceuticals had ₹1.52b of debt at September 2020, down from ₹1.85b a year prior. However, it also had ₹876.3m in cash, and so its net debt is ₹641.8m.
A Look At Suven Pharmaceuticals' Liabilities
The latest balance sheet data shows that Suven Pharmaceuticals had liabilities of ₹2.16b due within a year, and liabilities of ₹919.4m falling due after that. On the other hand, it had cash of ₹876.3m and ₹1.06b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.15b.
Having regard to Suven Pharmaceuticals' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹122.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Suven Pharmaceuticals has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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).
Suven Pharmaceuticals has a low net debt to EBITDA ratio of only 0.15. And its EBIT easily covers its interest expense, being 30.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Suven Pharmaceuticals has increased its EBIT by 7.4% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Suven Pharmaceuticals's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Suven Pharmaceuticals produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Suven Pharmaceuticals's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Looking at the bigger picture, we think Suven Pharmaceuticals's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Suven Pharmaceuticals insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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