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. We note that Godfrey Phillips India Limited (NSE:GODFRYPHLP) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Godfrey Phillips India
What Is Godfrey Phillips India's Net Debt?
As you can see below, Godfrey Phillips India had ₹486.4m of debt, at September 2019, which is about the same as the year before. You can click the chart for greater detail. But it also has ₹3.79b in cash to offset that, meaning it has ₹3.30b net cash.
How Strong Is Godfrey Phillips India's Balance Sheet?
The latest balance sheet data shows that Godfrey Phillips India had liabilities of ₹7.44b due within a year, and liabilities of ₹3.49b falling due after that. On the other hand, it had cash of ₹3.79b and ₹1.16b worth of receivables due within a year. So its liabilities total ₹5.98b more than the combination of its cash and short-term receivables.
Of course, Godfrey Phillips India has a market capitalization of ₹48.1b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Godfrey Phillips India also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, Godfrey Phillips India grew its EBIT by 63% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Godfrey Phillips India 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Godfrey Phillips India 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 last three years, Godfrey Phillips India actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing up
Although Godfrey Phillips India's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹3.30b. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in ₹2.5b. So we don't think Godfrey Phillips India's use of debt is risky. 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 Godfrey Phillips India that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.