These 4 Measures Indicate That Gillanders Arbuthnot (NSE:GILLANDERS) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Gillanders Arbuthnot and Company Limited (NSE:GILLANDERS) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Gillanders Arbuthnot

What Is Gillanders Arbuthnot's Net Debt?

The image below, which you can click on for greater detail, shows that Gillanders Arbuthnot had debt of ₹2.66b at the end of September 2020, a reduction from ₹3.55b over a year. On the flip side, it has ₹931.5m in cash leading to net debt of about ₹1.72b.

How Healthy Is Gillanders Arbuthnot's Balance Sheet?

The latest balance sheet data shows that Gillanders Arbuthnot had liabilities of ₹3.58b due within a year, and liabilities of ₹1.36b falling due after that. Offsetting this, it had ₹931.5m in cash and ₹721.1m in receivables that were due within 12 months. So it has liabilities totalling ₹3.28b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₹661.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Gillanders Arbuthnot would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.24 times and a disturbingly high net debt to EBITDA ratio of 6.3 hit our confidence in Gillanders Arbuthnot like a one-two punch to the gut. The debt burden here is substantial. Even worse, Gillanders Arbuthnot saw its EBIT tank 71% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Gillanders Arbuthnot will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Gillanders Arbuthnot actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both Gillanders Arbuthnot's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. After considering the datapoints discussed, we think Gillanders Arbuthnot has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Gillanders Arbuthnot that you should be aware of.

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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