These 4 Measures Indicate That GP Petroleums (NSE:GULFPETRO) Is Using Debt Reasonably Well

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that GP Petroleums Limited (NSE:GULFPETRO) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for GP Petroleums

What Is GP Petroleums's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 GP Petroleums had debt of ₹190.4m, up from ₹116.4m in one year. On the flip side, it has ₹6.36m in cash leading to net debt of about ₹184.0m.

How Strong Is GP Petroleums' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that GP Petroleums had liabilities of ₹665.0m due within 12 months and liabilities of ₹129.8m due beyond that. On the other hand, it had cash of ₹6.36m and ₹1.52b worth of receivables due within a year. So it actually has ₹729.1m more liquid assets than total liabilities.

This excess liquidity suggests that GP Petroleums is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders.

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.

GP Petroleums has a low net debt to EBITDA ratio of only 0.55. And its EBIT easily covers its interest expense, being 17.1 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact GP Petroleums's saving grace is its low debt levels, because its EBIT has tanked 34% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since GP Petroleums 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, GP Petroleums recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that GP Petroleums's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that GP Petroleums can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. For instance, we've identified 1 warning sign for GP Petroleums 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.