Does Vaishali Pharma (NSE:VAISHALI) Have A Healthy Balance Sheet?

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. As with many other companies Vaishali Pharma Limited (NSE:VAISHALI) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Vaishali Pharma

How Much Debt Does Vaishali Pharma Carry?

As you can see below, Vaishali Pharma had ₹158.2m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₹4.13m in cash leading to net debt of about ₹154.1m.

How Healthy Is Vaishali Pharma's Balance Sheet?

We can see from the most recent balance sheet that Vaishali Pharma had liabilities of ₹370.2m falling due within a year, and liabilities of ₹47.1m due beyond that. Offsetting this, it had ₹4.13m in cash and ₹434.0m in receivables that were due within 12 months. So it can boast ₹20.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Vaishali Pharma could probably pay off its debt with ease, as its balance sheet is far from stretched.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Vaishali Pharma shareholders face the double whammy of a high net debt to EBITDA ratio (20.2), and fairly weak interest coverage, since EBIT is just 0.42 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Vaishali Pharma's EBIT was down 79% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Vaishali Pharma will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Vaishali Pharma recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

While Vaishali Pharma's interest cover makes us cautious about it, its track record of (not) growing its EBIT is no better. At least its conversion of EBIT to free cash flow gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Vaishali Pharma is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 5 warning signs for Vaishali Pharma (3 make us uncomfortable) 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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