Is Graphite India (NSE:GRAPHITE) Using Debt Sensibly?

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. We can see that Graphite India Limited (NSE:GRAPHITE) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Graphite India

What Is Graphite India's Net Debt?

The image below, which you can click on for greater detail, shows that Graphite India had debt of ₹3.16b at the end of September 2020, a reduction from ₹3.94b over a year. However, its balance sheet shows it holds ₹21.4b in cash, so it actually has ₹18.2b net cash.

How Healthy Is Graphite India's Balance Sheet?

According to the last reported balance sheet, Graphite India had liabilities of ₹8.72b due within 12 months, and liabilities of ₹760.0m due beyond 12 months. Offsetting these obligations, it had cash of ₹21.4b as well as receivables valued at ₹4.65b due within 12 months. So it actually has ₹16.5b more liquid assets than total liabilities.

This excess liquidity suggests that Graphite India is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Graphite India has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Graphite India can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Graphite India had a loss before interest and tax, and actually shrunk its revenue by 52%, to ₹20b. That makes us nervous, to say the least.

So How Risky Is Graphite India?

Although Graphite India had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of ₹3.5b. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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 Graphite India is showing 1 warning sign in our investment analysis , you should know about...

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.

If you decide to trade Graphite India, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all 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.