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Is Ajanta Pharma (NSE:AJANTPHARM) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Ajanta Pharma Limited (NSE:AJANTPHARM) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ajanta Pharma

What Is Ajanta Pharma's Debt?

As you can see below, at the end of March 2019, Ajanta Pharma had ₹542.5m of debt, up from ₹41.2m a year ago. Click the image for more detail. But it also has ₹1.60b in cash to offset that, meaning it has ₹1.06b net cash.

NSEI:AJANTPHARM Historical Debt, September 4th 2019
NSEI:AJANTPHARM Historical Debt, September 4th 2019

How Healthy Is Ajanta Pharma's Balance Sheet?

We can see from the most recent balance sheet that Ajanta Pharma had liabilities of ₹3.78b falling due within a year, and liabilities of ₹733.3m due beyond that. Offsetting this, it had ₹1.60b in cash and ₹5.41b in receivables that were due within 12 months. So it actually has ₹2.50b more liquid assets than total liabilities.

This short term liquidity is a sign that Ajanta Pharma could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Ajanta Pharma has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Ajanta Pharma if management cannot prevent a repeat of the 20% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ajanta Pharma's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Ajanta Pharma has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Ajanta Pharma created free cash flow amounting to 17% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Ajanta Pharma has ₹1.1b in net cash and a decent-looking balance sheet. So we don't have any problem with Ajanta Pharma's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Ajanta Pharma, you may well want to click here to check an interactive graph of its earnings per share history.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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