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 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, Advanced Enzyme Technologies Limited (NSE:ADVENZYMES) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Advanced Enzyme Technologies's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Advanced Enzyme Technologies had ₹345.9m of debt in March 2019, down from ₹576.4m, one year before. However, it does have ₹1.35b in cash offsetting this, leading to net cash of ₹1.01b.
How Strong Is Advanced Enzyme Technologies's Balance Sheet?
The latest balance sheet data shows that Advanced Enzyme Technologies had liabilities of ₹704.9m due within a year, and liabilities of ₹357.9m falling due after that. Offsetting these obligations, it had cash of ₹1.35b as well as receivables valued at ₹605.4m due within 12 months. So it actually has ₹895.1m more liquid assets than total liabilities.
This short term liquidity is a sign that Advanced Enzyme Technologies could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Advanced Enzyme Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.
Fortunately, Advanced Enzyme Technologies grew its EBIT by 3.2% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Advanced Enzyme Technologies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Advanced Enzyme Technologies 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. Over the most recent three years, Advanced Enzyme Technologies recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Advanced Enzyme Technologies has net cash of ₹1.0b, as well as more liquid assets than liabilities. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in ₹1.2b. So is Advanced Enzyme Technologies's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Advanced Enzyme Technologies's earnings per share history for free.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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