Is GHCL Textiles (NSE:GHCLTEXTIL) 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies GHCL Textiles Limited (NSE:GHCLTEXTIL) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for GHCL Textiles

What Is GHCL Textiles's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 GHCL Textiles had debt of ₹718.2m, up from none in one year. However, it does have ₹103.0m in cash offsetting this, leading to net debt of about ₹615.2m.

How Healthy Is GHCL Textiles' Balance Sheet?

The latest balance sheet data shows that GHCL Textiles had liabilities of ₹894.1m due within a year, and liabilities of ₹1.58b falling due after that. Offsetting these obligations, it had cash of ₹103.0m as well as receivables valued at ₹1.26b due within 12 months. So its liabilities total ₹1.11b more than the combination of its cash and short-term receivables.

Of course, GHCL Textiles has a market capitalization of ₹10.2b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 0.74 times EBITDA, GHCL Textiles is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.5 times the interest expense over the last year. It was also good to see that despite losing money on the EBIT line last year, GHCL Textiles turned things around in the last 12 months, delivering and EBIT of ₹363m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since GHCL Textiles will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, GHCL Textiles burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

GHCL Textiles's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its net debt to EBITDA was refreshing. Looking at all the angles mentioned above, it does seem to us that GHCL Textiles is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for GHCL Textiles that 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.

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