Is IOL Chemicals and Pharmaceuticals (NSE:IOLCP) Using Too Much Debt?

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Simply Wall St

Thu, Aug 29, 2019, 2:10 AM

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.' 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. Importantly, IOL Chemicals and Pharmaceuticals Limited (NSE:IOLCP) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for IOL Chemicals and Pharmaceuticals

What Is IOL Chemicals and Pharmaceuticals's Debt?

You can click the graphic below for the historical numbers, but it shows that IOL Chemicals and Pharmaceuticals had ₹2.84b of debt in March 2019, down from ₹3.93b, one year before. However, because it has a cash reserve of ₹134.7m, its net debt is less, at about ₹2.71b.

NSEI:IOLCP Historical Debt, August 29th 2019

A Look At IOL Chemicals and Pharmaceuticals's Liabilities

According to the last reported balance sheet, IOL Chemicals and Pharmaceuticals had liabilities of ₹2.57b due within 12 months, and liabilities of ₹2.11b due beyond 12 months. Offsetting these obligations, it had cash of ₹134.7m as well as receivables valued at ₹2.02b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.52b.

IOL Chemicals and Pharmaceuticals has a market capitalization of ₹10.3b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

IOL Chemicals and Pharmaceuticals has a low net debt to EBITDA ratio of only 0.53. And its EBIT easily covers its interest expense, being 12.8 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, IOL Chemicals and Pharmaceuticals grew its EBIT by 351% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 IOL Chemicals and Pharmaceuticals 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. So we always check how much of that EBIT is translated into free cash flow. During the last three years, IOL Chemicals and Pharmaceuticals produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that IOL Chemicals and Pharmaceuticals's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Looking at the bigger picture, we think IOL Chemicals and Pharmaceuticals's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Over time, share prices tend to follow earnings per share, so if you're interested in IOL Chemicals and Pharmaceuticals, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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.

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