Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Vadivarhe Specialty Chemicals Limited (NSE:VSCL) is in debt. But should shareholders worry about its use of debt?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Vadivarhe Specialty Chemicals
What is Vadivarhe Specialty Chemicals’ debt?
As you can see below, at the end of September 2021, Vadivarhe Specialty Chemicals had a debt of ₹241.9 million, up from ₹195.8 million a year ago. Click on the image for more details. However, he also had ₹7.23 million in cash, and hence his net debt is ₹234.7 million.
How healthy is Vadivarhe Specialty Chemicals’ balance sheet?
According to the latest published balance sheet, Vadivarhe Specialty Chemicals had liabilities of ₹217.4 million due within 12 months and liabilities of ₹148.6 million due beyond 12 months. On the other hand, it had cash of ₹7.23 million and ₹110.0 million in receivables due within one year. It therefore has liabilities totaling £248.8 million more than its cash and short-term receivables, combined.
This shortfall is sizable compared to its market capitalization of ₹375.8 million, so it suggests shareholders to monitor Vadivarhe Specialty Chemicals’ use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of Vadivarhe Specialty Chemicals that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
On a 12-month basis, Vadivarhe Specialty Chemicals recorded a loss in EBIT and saw its revenue fall to ₹226 million, a decline of 13%. We would much rather see growth.
Caveat Emptor
While Vadivarhe Specialty Chemicals’ revenue decline is about as comforting as a wet blanket, its earnings before interest and tax (EBIT) loss is arguably even less appealing. Indeed, it lost a very considerable ₹45 million in EBIT. When we look at this and recall the liabilities on its balance sheet, versus cash, it seems unwise to us that the company has debt. So we think its balance sheet is a little stretched, but not beyond repair. However, it doesn’t help that he burned through ₹16 million in cash in the past year. So suffice it to say that we consider the stock to be risky. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that Vadivarhe Specialty Chemicals shows 4 warning signs in our investment analysis and 3 of them don’t suit us too much…
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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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.
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