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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Laurus Labs Limited (NSE:LAURUSLABS) does use debt in its business. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Laurus Labs
What Is Laurus Labs's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Laurus Labs had ₹10.4b of debt, an increase on ₹9.80b, over one year. Net debt is about the same, since the it doesn't have much cash.
How Healthy Is Laurus Labs's Balance Sheet?
We can see from the most recent balance sheet that Laurus Labs had liabilities of ₹14.2b falling due within a year, and liabilities of ₹3.49b due beyond that. On the other hand, it had cash of ₹30.2m and ₹7.31b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹10.4b.
This deficit isn't so bad because Laurus Labs is worth ₹34.9b, 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.
Laurus Labs has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 2.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Another concern for investors might be that Laurus Labs's EBIT fell 18% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Laurus Labs's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.