These 4 metrics indicate that Vinati Organics (NSE:VINATIORGA) uses debt reasonably well
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Vinati Organics Limited (NSE:VINATIORGA) uses debt. But should shareholders worry about its use of debt?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business 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.
See our latest analysis for Vinati Organics
What is Vinati Organics net debt?
You can click on the graph below for historical figures, but it shows that in March 2022, Vinati Organics had a debt of ₹184.0 million, an increase from ₹20.2 million, on a year. On the other hand, he has ₹44.1 million in cash, resulting in a net debt of around ₹139.9 million.
A look at the responsibilities of Vinati Organics
We can see from the most recent balance sheet that Vinati Organics had liabilities of ₹1.67 billion due within a year, and liabilities of ₹944.8 million due beyond that. As compensation for these obligations, it had cash of ₹44.1 million as well as receivables valued at ₹4.76 billion due within 12 months. So he actually has ₹2.19 billion After liquid assets than total liabilities.
Given the size of Vinati Organics, it appears its cash is well balanced with its total liabilities. It is therefore highly unlikely that the ₹204.7bn company will run out of cash, but it is still worth keeping an eye on the balance sheet. Having virtually no net debt, Vinati Organics indeed has very little debt.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Vinati Organics has very little debt (net of cash) and has a debt/EBITDA ratio of 0.032 and an EBIT of 2,000 times interest expense. Thus, compared to past earnings, the level of debt seems insignificant. Another good sign, Vinati Organics was able to increase its EBIT by 26% in twelve months, thus facilitating the repayment of its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Vinati Organics will need income to repay this debt. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Vinati Organics has created free cash flow amounting to 18% of its EBIT, an uninspiring performance. This low level of cash conversion compromises its ability to manage and repay its debt.
Our point of view
Fortunately, Vinati Organics’ impressive interest coverage means it has the upper hand on its debt. But truth be told, we think his conversion of EBIT to free cash flow somewhat undermines that impression. Zooming out, Vinati Organics seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 1 warning sign for Vinati Organics you should be aware.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.