Godrej Consumer Products (NSE:GODREJCP) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Godrej Consumer Products Limited (NSE:GODREJCP) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Godrej Consumer Products

What Is Godrej Consumer Products's Debt?

The image below, which you can click on for greater detail, shows that Godrej Consumer Products had debt of ₹10.6b at the end of September 2022, a reduction from ₹21.3b over a year. However, its balance sheet shows it holds ₹16.7b in cash, so it actually has ₹6.09b net cash.

A Look At Godrej Consumer Products' Liabilities

The latest balance sheet data shows that Godrej Consumer Products had liabilities of ₹32.6b due within a year, and liabilities of ₹5.92b falling due after that. Offsetting this, it had ₹16.7b in cash and ₹10.9b in receivables that were due within 12 months. So it has liabilities totalling ₹10.8b more than its cash and near-term receivables, combined.

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 ₹944.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Godrej Consumer Products also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Godrej Consumer Products's EBIT dived 12%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Godrej Consumer Products can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Godrej Consumer Products 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, Godrej Consumer Products produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Godrej Consumer Products's liabilities, but we can be reassured by the fact it has has net cash of ₹6.09b. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in ₹15b. So we don't have any problem with Godrej Consumer Products's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Godrej Consumer Products insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.