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. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Morepen Laboratories Limited (NSE:MOREPENLAB) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
How Much Debt Does Morepen Laboratories Carry?
The image below, which you can click on for greater detail, shows that Morepen Laboratories had debt of ₹108.2m at the end of March 2019, a reduction from ₹1.34b over a year. But it also has ₹325.0m in cash to offset that, meaning it has ₹216.8m net cash.
A Look At Morepen Laboratories's Liabilities
According to the last reported balance sheet, Morepen Laboratories had liabilities of ₹3.39b due within 12 months, and liabilities of ₹233.8m due beyond 12 months. Offsetting this, it had ₹325.0m in cash and ₹1.41b in receivables that were due within 12 months. So it has liabilities totalling ₹1.89b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Morepen Laboratories has a market capitalization of ₹8.21b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Morepen Laboratories boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Morepen Laboratories grew its EBIT by 5.2% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Morepen Laboratories will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Morepen Laboratories has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Morepen Laboratories produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While Morepen Laboratories does have more liabilities than liquid assets, it also has net cash of ₹216.8m. So we are not troubled with Morepen Laboratories's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Morepen Laboratories's earnings per share history for free.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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