These 4 Measures Indicate That Godfrey Phillips India (NSE:GODFRYPHLP) Is Using Debt Safely

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.' 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 Godfrey Phillips India Limited (NSE:GODFRYPHLP) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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, at the end of March 2023, Godfrey Phillips India had ₹3.55b of debt, up from ₹3.37b a year ago. Click the image for more detail. However, it also had ₹1.79b in cash, and so its net debt is ₹1.76b.

A Look At Godfrey Phillips India's Liabilities

Zooming in on the latest balance sheet data, we can see that Godfrey Phillips India had liabilities of ₹10.4b due within 12 months and liabilities of ₹3.75b due beyond that. Offsetting this, it had ₹1.79b in cash and ₹1.62b in receivables that were due within 12 months. So it has liabilities totalling ₹10.7b more than its cash and near-term receivables, combined.

Given Godfrey Phillips India has a market capitalization of ₹113.1b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Godfrey Phillips India has a low net debt to EBITDA ratio of only 0.20. And its EBIT covers its interest expense a whopping 23.9 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Godfrey Phillips India has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Godfrey Phillips India's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Godfrey Phillips India recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Godfrey Phillips India's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. We think Godfrey Phillips India is no more beholden to its lenders, than the birds are to birdwatchers. To our minds it has a healthy happy balance sheet. Over time, share prices tend to follow earnings per share, so if you're interested in Godfrey Phillips India, you may well want to click here to check an interactive graph of its earnings per share history.

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.