Howard Marks put it well when he said that, rather than worrying about stock price volatility, "the possibility of permanent loss is the risk I worry about...and every practical investor I know worries about." . When we think about a company's risk, we always like to look at its use of debt, since debt overload can lead to ruin. In a bombastic tone, Torrent Pharmaceuticals Limited (NSE:TORNTPHARM) yes you have debt. But the more important question is: how much risk is that debt creating?
Why does debt carry risks?
Debt helps a business until it has trouble paying it off, either with new capital or free cash flow. In the worst case scenario, a company can declare bankruptcy if it cannot pay its creditors. While this is not very common, we often see indebted companies permanently diluting their shareholders because lenders force them to raise capital at an unfavorable price. That said, the most common situation is one where a company manages its debt reasonably well and to its own benefit. The first thing to do when considering how much debt a company uses is to look at its cash and debt together.
View our latest analysis for Torrent Pharmaceuticals
What is Torrent Pharmaceuticals' net debt?
You can click on the chart below to see the historical figures, but it shows that in September 2023, Torrent Pharmaceuticals had debt of 44.9 billion rupees, an increase of 40.8 billion rupees, in one year . However, it also had โน7.90b in cash, so its net debt is โน37.0b.
How healthy is Torrent Pharmaceuticals' balance sheet?
We can see from the most recent balance sheet that Torrent Pharmaceuticals had liabilities of โน49.0b falling due within a year, and liabilities of โน31.4b falling due beyond that. Offsetting this, it had โน7.90b in cash and โน17.6b in receivables due within 12 months. So its liabilities total โน54.9b more than the combination of its cash and short-term receivables.
Given that Torrent Pharmaceuticals' publicly traded shares are worth a staggering total of 902.5 billion rupees, this level of liabilities seems unlikely to be a major threat. That said, it is clear that we must continue to monitor its balance sheet, so that it does not get worse.
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) cover its interest expense (or its interest coverage). interests, for short). . The advantage of this approach is that we take into account both the absolute amount of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest coverage ratio).
Looking at its net debt to EBITDA of 1.2 and its interest coverage of 6.6 times, it seems to us that Torrent Pharmaceuticals is probably using debt quite reasonably. But the interest payments are certainly enough to make us think about how affordable your debt is. Another good sign is that Torrent Pharmaceuticals has managed to increase its EBIT by 21% in twelve months, facilitating the amortization of its debt. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, the future profitability of the business will decide whether Torrent Pharmaceuticals 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.
Finally, a company needs free cash flow to pay off debt; accounting profits are simply not enough. That's why we always check how much of that EBIT translates into free cash flow. Over the last three years, Torrent Pharmaceuticals generated free cash flow that accounted for a solid 91% of its EBIT, more than we expected. That puts you in a very strong position to pay off the debt.
Our view
Torrent Pharmaceuticals' 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 goalkeeper. And the good news doesn't end there, as its EBIT growth rate also supports that impression. Looking at the bigger picture, we think Torrent Pharmaceuticals' use of debt seems quite reasonable and we are not concerned. After all, sensible leverage can increase returns on capital. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risk lies in the balance sheet, far from it. Case in point: we have detected 2 warning signs for Torrent Pharmaceuticals you should consider.
Of course, if you're the type of investor who prefers to buy stocks without the burden of debt, don't hesitate to find out Our Exclusive List of Net Cash Growth Stockstoday.
Valuation is complex, but we are helping to simplify it.
Find out if Torrente Pharmaceuticals is potentially overvalued or undervalued by checking out our full analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your objectives or financial situation. Our goal is to provide you with focused, long-term analysis driven by fundamental data. Please note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
