Torrent Pharmaceuticals (NSE: TORNTPHARM) Seems to Use Debt Quite Wisely

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Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Mostly, Torrent Pharmaceuticals Limited (NSE: TORNTPHARM) is in debt. But the most important question is: what risk does this debt create?

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest review for Torrent Pharmaceuticals

What is Torrent Pharmaceuticals net debt?

You can click on the chart below for historical figures, but it shows Torrent Pharmaceuticals had 51.0 billion yen in debt in March 2021, up from 58.0 billion yen a year earlier. However, it has 8.64 billion yen in cash offsetting this, which leads to net debt of around 42.3 billion yen.

NSEI: TORNTPHARM History of debt to equity July 2, 2021

A look at the responsibilities of Torrent Pharmaceuticals

The latest balance sheet data shows Torrent Pharmaceuticals had 48.9 billion yen in liabilities due within one year, and 33.5 billion yen liabilities due after that. In return, he had 8.64 billion yen in cash and 15.3 billion yen in receivables due within 12 months. Its liabilities therefore total 58.5 billion yen more than the combination of its cash and short-term receivables.

Of course, Torrent Pharmaceuticals has a market cap of 494.8 billion yen, so this liability is probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time.

We measure a company’s debt load relative to its earning capacity 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 costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Torrent Pharmaceuticals has net debt of 1.7 times EBITDA, which isn’t too much, but its interest coverage looks a bit weak, with EBIT just 5.1 times interest expense. While this doesn’t worry us too much, it does suggest that the interest payments are somewhat of a burden. We note that Torrent Pharmaceuticals has increased its EBIT by 20% over the past year, which should make it easier to repay debt in the future. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Torrent Pharmaceuticals’ ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Torrent Pharmaceuticals has generated free cash flow of a very strong 81% of EBIT, more than we expected. This positions it well to repay debt if it is desirable.

Our point of view

Torrent Pharmaceuticals’ EBIT conversion into free cash flow suggests it can manage debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And that’s just the start of the good news as its EBIT growth rate is also very encouraging. Looking at the big picture, we think Torrent Pharmaceuticals’ use of debt looks very reasonable and we don’t care. While debt comes with risk, when used wisely, it can also generate a higher return on equity. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Be aware that Torrent Pharmaceuticals shows 2 warning signs in our investment analysis , you must know…

If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.

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