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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Chemfab Alkalis Limited (NSE:CHEMFABALKA) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Chemfab Alkalis
What Is Chemfab Alkalis's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Chemfab Alkalis had ₹339.9m of debt, an increase on ₹227.1m, over one year. However, it also had ₹12.4m in cash, and so its net debt is ₹327.5m.
How Strong Is Chemfab Alkalis's Balance Sheet?
The latest balance sheet data shows that Chemfab Alkalis had liabilities of ₹366.4m due within a year, and liabilities of ₹332.4m falling due after that. Offsetting these obligations, it had cash of ₹12.4m as well as receivables valued at ₹211.2m due within 12 months. So it has liabilities totalling ₹475.3m more than its cash and near-term receivables, combined.
Chemfab Alkalis has a market capitalization of ₹2.23b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.