Graphite India (NSE:GRAPHITE) Takes On Some Risk With Its Use Of Debt

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.' 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. Importantly, Graphite India Limited (NSE:GRAPHITE) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Graphite India

How Much Debt Does Graphite India Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Graphite India had debt of ₹4.22b, up from ₹2.77b in one year. But on the other hand it also has ₹16.8b in cash, leading to a ₹12.6b net cash position.

How Healthy Is Graphite India's Balance Sheet?

We can see from the most recent balance sheet that Graphite India had liabilities of ₹15.3b falling due within a year, and liabilities of ₹1.31b due beyond that. Offsetting these obligations, it had cash of ₹16.8b as well as receivables valued at ₹5.70b due within 12 months. So it actually has ₹5.93b more liquid assets than total liabilities.

This surplus suggests that Graphite India has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Graphite India boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Graphite India's load is not too heavy, because its EBIT was down 47% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Graphite India can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Graphite India may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last two years, Graphite India burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Graphite India has ₹12.6b in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Graphite India's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Graphite India has 3 warning signs we think you should be aware of.

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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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.