Gokul Agro Resources (NSE:GOKULAGRO) Has A Somewhat Strained 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. We note that Gokul Agro Resources Limited (NSE:GOKULAGRO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Gokul Agro Resources

How Much Debt Does Gokul Agro Resources Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Gokul Agro Resources had debt of ₹2.76b, up from ₹2.64b in one year. But it also has ₹3.43b in cash to offset that, meaning it has ₹666.2m net cash.

How Strong Is Gokul Agro Resources' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gokul Agro Resources had liabilities of ₹12.0b due within 12 months and liabilities of ₹469.3m due beyond that. On the other hand, it had cash of ₹3.43b and ₹4.58b worth of receivables due within a year. So it has liabilities totalling ₹4.44b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₹2.97b, we think shareholders really should watch Gokul Agro Resources's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Gokul Agro Resources boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

The bad news is that Gokul Agro Resources saw its EBIT decline by 10% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Gokul Agro Resources 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, a company can only pay off debt with cold hard cash, not accounting profits. While Gokul Agro Resources 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. During the last three years, Gokul Agro Resources produced sturdy free cash flow equating to 72% 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.

Summing up

While Gokul Agro Resources does have more liabilities than liquid assets, it also has net cash of ₹666.2m. And it impressed us with free cash flow of ₹1.9b, being 72% of its EBIT. Despite its cash we think that Gokul Agro Resources seems to struggle to handle its total liabilities, so we are wary of the stock. 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. Be aware that Gokul Agro Resources is showing 4 warning signs in our investment analysis , and 1 of those is concerning...

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. 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.
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