Is Camlin Fine Sciences (NSE:CAMLINFINE) Using Too Much Debt?
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. 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 Camlin Fine Sciences Limited (NSE:CAMLINFINE) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund 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 Camlin Fine Sciences
What Is Camlin Fine Sciences's Debt?
The image below, which you can click on for greater detail, shows that at March 2019 Camlin Fine Sciences had debt of ₹4.61b, up from ₹3.73b in one year. However, it also had ₹985.4m in cash, and so its net debt is ₹3.62b.
How Strong Is Camlin Fine Sciences's Balance Sheet?
The latest balance sheet data shows that Camlin Fine Sciences had liabilities of ₹4.60b due within a year, and liabilities of ₹1.96b falling due after that. Offsetting these obligations, it had cash of ₹985.4m as well as receivables valued at ₹2.22b due within 12 months. So it has liabilities totalling ₹3.36b more than its cash and near-term receivables, combined.
Camlin Fine Sciences has a market capitalization of ₹7.35b, 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 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.
Camlin Fine Sciences's debt is 4.1 times its EBITDA, and its EBIT cover its interest expense 3.3 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, it should be some comfort for shareholders to recall that Camlin Fine Sciences actually grew its EBIT by a hefty 434%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Camlin Fine Sciences's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last two years, Camlin Fine Sciences burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
Camlin Fine Sciences's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Camlin Fine Sciences is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. Given our hesitation about the stock, it would be good to know if Camlin Fine Sciences insiders have sold any shares recently. You click here to find out if insiders have sold recently.
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.
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