Warren Buffett said: “Volatility is far from synonymous with risk”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We note that Torrent Pharmaceuticals Limited (NSE: TORNTPHARM) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest review for Torrent Pharmaceuticals
What is the debt of Torrent Pharmaceuticals?
The image below, which you can click for more details, shows Torrent Pharmaceuticals owed 49.3 billion yen at the end of March 2021, a reduction from 58.5 billion yen on a year. On the other hand, it has 7.38 billion yen in cash, resulting in net debt of around 41.9 billion yen.
How healthy is Torrent Pharmaceuticals’ track record?
The latest balance sheet data shows Torrent Pharmaceuticals had 48.9 billion yen in liabilities due within one year, and 33.5 billion yen liabilities due after that. On the other hand, he had a cash position of 7.38 billion yen and 18.9 billion yen in receivables due within a year. Its liabilities are therefore € 56.1 billion more than the combination of its cash and short-term receivables.
Considering that Torrent Pharmaceuticals’ listed shares are worth a total of 530.5 billion yen, it seems unlikely that this level of liabilities is a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Torrent Pharmaceuticals’ net debt stands at a very reasonable level of 1.7 times its EBITDA, while its EBIT only covered its interest expense 5.8 times last year. While this doesn’t worry us too much, it does suggest that the interest payments are somewhat of a burden. If Torrent Pharmaceuticals can continue to grow its EBIT at the 12% rate last year compared to last year, then it will find its debt more manageable. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Torrent Pharmaceuticals’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Torrent Pharmaceuticals has generated free cash flow of a very solid 80% of its EBIT, more than we expected. This positions it well to repay debt if it is desirable.
Our point of view
Torrent Pharmaceuticals’ EBIT conversion to free cash flow suggests that it can manage its debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And we also thought its EBIT growth rate was positive. When we consider the range of factors above, it looks like Torrent Pharmaceuticals is pretty reasonable with its use of debt. This means that they are taking a bit more risk, in the hope of increasing returns for shareholders. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. Example: we have spotted 2 warning signs for Torrent Pharmaceuticals you must be aware.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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 goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
If you decide to trade Torrent Pharmaceuticals, use the cheapest platform * which is ranked # 1 overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, currencies, bonds and funds in 135 markets, all from one integrated account.Promoted
