Zydus Lifesciences (NSE:ZYDUSLIFE) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Zydus Lifesciences Limited (NSE:ZYDUSLIFE) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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 Zydus Lifesciences

What Is Zydus Lifesciences's Debt?

As you can see below, Zydus Lifesciences had ₹24.5b of debt at September 2022, down from ₹46.8b a year prior. On the flip side, it has ₹17.5b in cash leading to net debt of about ₹6.98b.

How Strong Is Zydus Lifesciences' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zydus Lifesciences had liabilities of ₹61.2b due within 12 months and liabilities of ₹7.41b due beyond that. Offsetting this, it had ₹17.5b in cash and ₹37.2b in receivables that were due within 12 months. So its liabilities total ₹13.9b more than the combination of its cash and short-term receivables.

Given Zydus Lifesciences has a market capitalization of ₹478.8b, 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. But either way, Zydus Lifesciences has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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).

Zydus Lifesciences has a low net debt to EBITDA ratio of only 0.21. And its EBIT covers its interest expense a whopping 44.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Zydus Lifesciences saw its EBIT drop by 3.7% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zydus Lifesciences'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Zydus Lifesciences produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Zydus Lifesciences's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Taking all this data into account, it seems to us that Zydus Lifesciences takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Zydus Lifesciences you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.