Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Sharda Cropchem Limited (NSE:SHARDACROP) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
What Is Sharda Cropchem's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Sharda Cropchem had ₹926.0k of debt in March 2019, down from ₹1.70b, one year before. However, it does have ₹3.37b in cash offsetting this, leading to net cash of ₹3.37b.
A Look At Sharda Cropchem's Liabilities
The latest balance sheet data shows that Sharda Cropchem had liabilities of ₹8.23b due within a year, and liabilities of ₹965.3m falling due after that. Offsetting these obligations, it had cash of ₹3.37b as well as receivables valued at ₹8.34b due within 12 months. So it actually has ₹2.52b more liquid assets than total liabilities.
This surplus suggests that Sharda Cropchem has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sharda Cropchem has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Sharda Cropchem's saving grace is its low debt levels, because its EBIT has tanked 37% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Sharda Cropchem 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. Sharda Cropchem may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Sharda Cropchem recorded free cash flow of 50% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to investigate a company's debt, in this case Sharda Cropchem has ₹3.4b in net cash and a decent-looking balance sheet. So we don't have any problem with Sharda Cropchem's use of debt. 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 Sharda Cropchem's earnings per share history for free.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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