Is Godrej Consumer Products (NSE:GODREJCP) A Risky Investment?

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 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. Importantly, Godrej Consumer Products Limited (NSE:GODREJCP) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider 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 2021, Godrej Consumer Products had ₹21.3b of debt, up from ₹11.9b a year ago. Click the image for more detail. On the flip side, it has ₹16.8b in cash leading to net debt of about ₹4.53b.

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 ₹41.6b due within 12 months and liabilities of ₹6.00b due beyond that. On the other hand, it had cash of ₹16.8b and ₹10.4b worth of receivables due within a year. So its liabilities total ₹20.3b more than the combination of its cash and short-term receivables.

Since publicly traded Godrej Consumer Products shares are worth a very impressive total of ₹979.2b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Godrej Consumer Products has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Godrej Consumer Products's net debt is only 0.18 times its EBITDA. And its EBIT easily covers its interest expense, being 71.8 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Godrej Consumer Products grew its EBIT by 15% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Godrej Consumer Products can strengthen its balance sheet over time. 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 we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Godrej Consumer Products recorded free cash flow worth 72% 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 we're not worried about the use of a little leverage on the balance sheet. Another factor that would give us confidence in Godrej Consumer Products would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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. 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.