Gammon Infrastructure Projects (NSE:GAMMNINFRA) Use Of Debt Could Be Considered Risky

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Gammon Infrastructure Projects Limited (NSE:GAMMNINFRA) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Gammon Infrastructure Projects

What Is Gammon Infrastructure Projects's Net Debt?

The image below, which you can click on for greater detail, shows that Gammon Infrastructure Projects had debt of ₹29.0b at the end of September 2020, a reduction from ₹38.9b over a year. However, it also had ₹1.35b in cash, and so its net debt is ₹27.7b.

A Look At Gammon Infrastructure Projects' Liabilities

We can see from the most recent balance sheet that Gammon Infrastructure Projects had liabilities of ₹27.0b falling due within a year, and liabilities of ₹8.88b due beyond that. On the other hand, it had cash of ₹1.35b and ₹512.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹34.0b.

This deficit casts a shadow over the ₹744.0m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Gammon Infrastructure Projects would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.053 times and a disturbingly high net debt to EBITDA ratio of 26.9 hit our confidence in Gammon Infrastructure Projects like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Gammon Infrastructure Projects's EBIT was down 85% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Gammon Infrastructure Projects's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Gammon Infrastructure Projects actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, Gammon Infrastructure Projects's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think Gammon Infrastructure Projects has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Gammon Infrastructure Projects is showing 4 warning signs in our investment analysis , and 1 of those is potentially serious...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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