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Is Alembic Pharmaceuticals (NSE:APLLTD) A Risky Investment?

Simply Wall St

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Alembic Pharmaceuticals Limited (NSE:APLLTD) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Alembic Pharmaceuticals

How Much Debt Does Alembic Pharmaceuticals Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2019 Alembic Pharmaceuticals had ₹11.3b of debt, an increase on ₹7.08b, over one year. On the flip side, it has ₹1.99b in cash leading to net debt of about ₹9.29b.

NSEI:APLLTD Historical Debt, September 9th 2019

A Look At Alembic Pharmaceuticals's Liabilities

Zooming in on the latest balance sheet data, we can see that Alembic Pharmaceuticals had liabilities of ₹14.9b due within 12 months and liabilities of ₹5.70b due beyond that. Offsetting these obligations, it had cash of ₹1.99b as well as receivables valued at ₹4.89b due within 12 months. So it has liabilities totalling ₹13.7b more than its cash and near-term receivables, combined.

Since publicly traded Alembic Pharmaceuticals shares are worth a total of ₹93.1b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Alembic Pharmaceuticals's net debt is only 1.0 times its EBITDA. And its EBIT easily covers its interest expense, being 47.2 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Alembic Pharmaceuticals has boosted its EBIT by 46%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Alembic 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Alembic Pharmaceuticals saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Alembic Pharmaceuticals is not finding it easy conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Considering this range of data points, we think Alembic Pharmaceuticals is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Alembic Pharmaceuticals insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.