Stock Analysis

Bharat Petroleum (NSE:BPCL) Has A Somewhat Strained Balance Sheet

NSEI:BPCL
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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Bharat Petroleum Corporation Limited (NSE:BPCL) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Bharat Petroleum

How Much Debt Does Bharat Petroleum Carry?

As you can see below, Bharat Petroleum had ₹503.0b of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had ₹170.5b in cash, and so its net debt is ₹332.5b.

debt-equity-history-analysis
NSEI:BPCL Debt to Equity History December 24th 2021

How Strong Is Bharat Petroleum's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Bharat Petroleum had liabilities of ₹842.4b due within 12 months and liabilities of ₹541.6b due beyond that. Offsetting these obligations, it had cash of ₹170.5b as well as receivables valued at ₹73.7b due within 12 months. So it has liabilities totalling ₹1.14t more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's massive market capitalization of ₹818.6b, we think shareholders really should watch Bharat Petroleum's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Bharat Petroleum's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 12.4 times its interest expense, implies the debt load is as light as a peacock feather. In addition to that, we're happy to report that Bharat Petroleum has boosted its EBIT by 64%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Bharat Petroleum 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Bharat Petroleum's free cash flow amounted to 38% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

While Bharat Petroleum's level of total liabilities has us nervous. To wit both its interest cover and EBIT growth rate were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Bharat Petroleum 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. 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. We've identified 4 warning signs with Bharat Petroleum , and understanding them should be part of your investment process.

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.

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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.