Gujarat Ambuja Exports (NSE:GAEL) Could Easily Take On More 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 Gujarat Ambuja Exports Limited (NSE:GAEL) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Gujarat Ambuja Exports

How Much Debt Does Gujarat Ambuja Exports Carry?

As you can see below, at the end of March 2022, Gujarat Ambuja Exports had ₹2.69b of debt, up from ₹1.53b a year ago. Click the image for more detail. However, it does have ₹6.81b in cash offsetting this, leading to net cash of ₹4.12b.

How Healthy Is Gujarat Ambuja Exports' Balance Sheet?

According to the last reported balance sheet, Gujarat Ambuja Exports had liabilities of ₹5.61b due within 12 months, and liabilities of ₹733.7m due beyond 12 months. Offsetting these obligations, it had cash of ₹6.81b as well as receivables valued at ₹2.24b due within 12 months. So it can boast ₹2.71b more liquid assets than total liabilities.

This surplus suggests that Gujarat Ambuja Exports has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Gujarat Ambuja Exports has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Gujarat Ambuja Exports has boosted its EBIT by 36%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Gujarat Ambuja Exports will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Gujarat Ambuja Exports has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Gujarat Ambuja Exports recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Gujarat Ambuja Exports has net cash of ₹4.12b, as well as more liquid assets than liabilities. And we liked the look of last year's 36% year-on-year EBIT growth. So we don't think Gujarat Ambuja Exports's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Gujarat Ambuja Exports you should know about.

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.