David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Biocon Limited (NSE:BIOCON) has debt on its balance sheet. But should shareholders worry about its use of debt?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Biocon
What is Biocon’s net debt?
As you can see below, at the end of September 2021, Biocon had a debt of ₹47.4 billion, up from ₹26.9 billion a year ago. Click on the image for more details. However, he has ₹30.7 billion in cash to offset this, resulting in a net debt of around ₹16.7 billion.
How healthy is Biocon’s balance sheet?
According to the latest published balance sheet, Biocon had liabilities of ₹40.4 billion due within 12 months and liabilities of ₹59.2 billion due beyond 12 months. On the other hand, it had a cash position of ₹30.7 billion and ₹11.9 billion in receivables due within a year. Thus, its liabilities total ₹56.9 billion more than the combination of its cash and short-term receivables.
Given that publicly traded Biocon shares are worth a total of ₹415.0 billion, it seems unlikely that this level of liabilities will pose a major threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Biocon’s net debt is only 0.89 times its EBITDA. And its EBIT easily covers its interest costs, which is 75.1 times the size. So we’re pretty relaxed about his super conservative use of debt. Another good sign, Biocon was able to increase its EBIT by 24% in twelve months, thus facilitating the repayment of its debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Biocon can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Biocon has burned through a lot of cash. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
Biocon’s conversion of EBIT to free cash flow was a real negative in this analysis, even though the other factors we considered were considerably better. There is no doubt that its ability to cover its interest costs with its EBIT is quite flashy. Given this range of data points, we believe Biocon is in a good position to manage its level of leverage. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 1 warning sign for Biocon which you should be aware of before investing here.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.