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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Gillanders Arbuthnot and Company Limited (NSE:GILLANDERS) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Gillanders Arbuthnot

What Is Gillanders Arbuthnot's Debt?

You can click the graphic below for the historical numbers, but it shows that Gillanders Arbuthnot had ₹1.45b of debt in March 2023, down from ₹1.83b, one year before. Net debt is about the same, since the it doesn't have much cash.

How Strong Is Gillanders Arbuthnot's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gillanders Arbuthnot had liabilities of ₹2.28b due within 12 months and liabilities of ₹460.0m due beyond that. Offsetting this, it had ₹26.7m in cash and ₹553.9m in receivables that were due within 12 months. So it has liabilities totalling ₹2.16b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's ₹1.65b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.79 times and a disturbingly high net debt to EBITDA ratio of 6.4 hit our confidence in Gillanders Arbuthnot like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Gillanders Arbuthnot saw its EBIT tank 63% 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 it is Gillanders Arbuthnot'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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Gillanders Arbuthnot 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

To be frank both Gillanders Arbuthnot's interest cover and its track record of (not) growing its EBIT 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. Overall, it seems to us that Gillanders Arbuthnot's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Gillanders Arbuthnot (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.