Is GMM Pfaudler (NSE:GMMPFAUDLR) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that GMM Pfaudler Limited (NSE:GMMPFAUDLR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, 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 capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 GMM Pfaudler

What Is GMM Pfaudler's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 GMM Pfaudler had ₹405.9m of debt, an increase on ₹245.6m, over one year. But it also has ₹2.22b in cash to offset that, meaning it has ₹1.82b net cash.

How Strong Is GMM Pfaudler's Balance Sheet?

We can see from the most recent balance sheet that GMM Pfaudler had liabilities of ₹1.88b falling due within a year, and liabilities of ₹777.3m due beyond that. On the other hand, it had cash of ₹2.22b and ₹894.6m worth of receivables due within a year. So it actually has ₹464.1m more liquid assets than total liabilities.

This state of affairs indicates that GMM Pfaudler's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹63.1b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, GMM Pfaudler boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that GMM Pfaudler grew its EBIT by 14% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine GMM Pfaudler's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While GMM Pfaudler has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, GMM Pfaudler's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case GMM Pfaudler has ₹1.82b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 14% over the last year. So we don't have any problem with GMM Pfaudler's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of GMM Pfaudler's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you’re looking to trade GMM Pfaudler, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.