Does Hindustan Petroleum (NSE:HINDPETRO) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Hindustan Petroleum Corporation Limited (NSE:HINDPETRO) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Hindustan Petroleum

What Is Hindustan Petroleum's Net Debt?

The image below, which you can click on for greater detail, shows that Hindustan Petroleum had debt of ₹628.1b at the end of March 2024, a reduction from ₹670.5b over a year. On the flip side, it has ₹56.6b in cash leading to net debt of about ₹571.6b.

How Strong Is Hindustan Petroleum's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hindustan Petroleum had liabilities of ₹864.3b due within 12 months and liabilities of ₹494.3b due beyond that. Offsetting these obligations, it had cash of ₹56.6b as well as receivables valued at ₹94.3b due within 12 months. So its liabilities total ₹1.21t more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹711.5b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Hindustan Petroleum would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a debt to EBITDA ratio of 2.1, Hindustan Petroleum uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 8.3 times its interest expenses harmonizes with that theme. We also note that Hindustan Petroleum improved its EBIT from a last year's loss to a positive ₹212b. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hindustan 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Hindustan Petroleum produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Mulling over Hindustan Petroleum's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Hindustan Petroleum stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Hindustan Petroleum (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.