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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.' 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. Importantly, Solara Active Pharma Sciences Limited (NSE:SOLARA) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Solara Active Pharma Sciences
What Is Solara Active Pharma Sciences's Debt?
The image below, which you can click on for greater detail, shows that Solara Active Pharma Sciences had debt of ₹5.34b at the end of March 2019, a reduction from ₹6.33b over a year. On the flip side, it has ₹761.6m in cash leading to net debt of about ₹4.58b.
A Look At Solara Active Pharma Sciences's Liabilities
The latest balance sheet data shows that Solara Active Pharma Sciences had liabilities of ₹6.55b due within a year, and liabilities of ₹3.44b falling due after that. Offsetting this, it had ₹761.6m in cash and ₹3.34b in receivables that were due within 12 months. So its liabilities total ₹5.90b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Solara Active Pharma Sciences is worth ₹10.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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.