Warren Buffett said: “Volatility is far from synonymous with risk. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Laurus Labs Limited (NSE:LAURUSLABS) uses debt in its business. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Laurus Labs
What is Laurus Labs’ net debt?
As you can see below, at the end of September 2021, Laurus Labs had a debt of ₹17.6 billion, up from ₹9.32 billion a year ago. Click on the image for more details. However, he has ₹386.7 million in cash to offset this, resulting in a net debt of around ₹17.3 billion.
A look at the responsibilities of Laurus Labs
According to the latest published balance sheet, Laurus Labs had liabilities of ₹25.2 billion due within 12 months and liabilities of ₹8.37 billion due beyond 12 months. On the other hand, it had a cash position of ₹386.7 million and ₹10.5 billion in receivables due within a year. Thus, its liabilities total ₹22.7 billion more than the combination of its cash and short-term receivables.
Given that publicly listed Laurus Labs shares are worth a total of ₹285.2 billion, it seems unlikely that this level of liabilities will pose a major threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Laurus Labs’ net debt is only 1.2 times its EBITDA. And its EBIT covers its interest charges 15.7 times. So we’re pretty relaxed about his super-conservative use of debt. And we also warmly note that Laurus Labs increased its EBIT by 17% last year, which makes it easier to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But future earnings, more than anything, will determine Laurus Labs’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay off its debts with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Laurus Labs has created free cash flow of 2.7% of its EBIT, an uninspiring performance. This low level of cash conversion compromises its ability to manage and repay its debt.
Our point of view
Laurus Labs’ interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But the harsh truth is that we are concerned about its conversion from EBIT to free cash flow. Looking at all of the aforementioned factors together, it seems to us that Laurus Labs can manage its debt quite comfortably. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. We have identified 2 warning signs with Laurus Labs, and understanding them should be part of your investment process.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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