Torrent Pharmaceuticals (NSE:TORNTPHARM) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, '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 Torrent Pharmaceuticals Limited (NSE:TORNTPHARM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Torrent Pharmaceuticals

What Is Torrent Pharmaceuticals's Debt?

The image below, which you can click on for greater detail, shows that Torrent Pharmaceuticals had debt of ₹49.3b at the end of March 2021, a reduction from ₹58.5b over a year. On the flip side, it has ₹7.38b in cash leading to net debt of about ₹41.9b.

How Healthy Is Torrent Pharmaceuticals' Balance Sheet?

The latest balance sheet data shows that Torrent Pharmaceuticals had liabilities of ₹48.9b due within a year, and liabilities of ₹33.5b falling due after that. On the other hand, it had cash of ₹7.38b and ₹18.9b worth of receivables due within a year. So its liabilities total ₹56.1b more than the combination of its cash and short-term receivables.

Since publicly traded Torrent Pharmaceuticals shares are worth a total of ₹530.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Torrent Pharmaceuticals's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 5.8 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. If Torrent Pharmaceuticals can keep growing EBIT at last year's rate of 12% over the last year, then it will find its debt load easier to manage. 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 Torrent Pharmaceuticals'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Torrent Pharmaceuticals generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Torrent Pharmaceuticals's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And we also thought its EBIT growth rate was a positive. When we consider the range of factors above, it looks like Torrent Pharmaceuticals is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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 Torrent Pharmaceuticals you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

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