Is Graphite India (NSE:GRAPHITE) A Risky Investment?

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.' 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 Graphite India Limited (NSE:GRAPHITE) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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

What Is Graphite India's Net Debt?

As you can see below, Graphite India had ₹2.25b of debt at March 2021, down from ₹4.18b a year prior. But on the other hand it also has ₹21.3b in cash, leading to a ₹19.1b net cash position.

How Strong Is Graphite India's Balance Sheet?

According to the last reported balance sheet, Graphite India had liabilities of ₹8.91b due within 12 months, and liabilities of ₹977.8m due beyond 12 months. Offsetting this, it had ₹21.3b in cash and ₹5.58b in receivables that were due within 12 months. So it can boast ₹17.0b more liquid assets than total liabilities.

This short term liquidity is a sign that Graphite India could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Graphite India has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Graphite India made a loss at the EBIT level, last year, it was also good to see that it generated ₹1.3b in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Graphite India'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Graphite India 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. Over the last year, Graphite India 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.

Summing up

While it is always sensible to investigate a company's debt, in this case Graphite India has ₹19.1b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 398% of that EBIT to free cash flow, bringing in ₹5.1b. So we don't think Graphite India's use of debt is risky. 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, we've discovered 2 warning signs for Graphite India that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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