Does Godrej Consumer Products (NSE:GODREJCP) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Godrej Consumer Products Limited (NSE:GODREJCP) makes use of debt. But is this debt a concern to shareholders?

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. 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. 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. 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 Godrej Consumer Products

What Is Godrej Consumer Products's Debt?

As you can see below, at the end of September 2024, Godrej Consumer Products had ₹37.5b of debt, up from ₹32.0b a year ago. Click the image for more detail. On the flip side, it has ₹29.6b in cash leading to net debt of about ₹7.93b.

How Healthy Is Godrej Consumer Products' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Godrej Consumer Products had liabilities of ₹63.3b due within 12 months and liabilities of ₹4.87b due beyond that. Offsetting these obligations, it had cash of ₹29.6b as well as receivables valued at ₹16.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹22.1b.

This state of affairs indicates that Godrej Consumer Products' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹1.19t company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Godrej Consumer Products has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Godrej Consumer Products has a low net debt to EBITDA ratio of only 0.26. And its EBIT easily covers its interest expense, being 36.5 times the size. So we're pretty relaxed about its super-conservative use of debt. Also good is that Godrej Consumer Products grew its EBIT at 15% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Godrej Consumer Products's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Godrej Consumer Products recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Godrej Consumer Products's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Overall, we don't think Godrej Consumer Products is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Godrej Consumer Products has 1 warning sign we think you should be aware of.

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.