Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. Importantly, Galaxy Surfactants Limited (NSE:GALAXYSURF) does carry debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
View our latest analysis for Galaxy Surfactants
What Is Galaxy Surfactants's Debt?
You can click the graphic below for the historical numbers, but it shows that Galaxy Surfactants had ₹2.89b of debt in September 2019, down from ₹4.15b, one year before. However, it does have ₹400.9m in cash offsetting this, leading to net debt of about ₹2.49b.
A Look At Galaxy Surfactants's Liabilities
The latest balance sheet data shows that Galaxy Surfactants had liabilities of ₹5.71b due within a year, and liabilities of ₹1.22b falling due after that. Offsetting these obligations, it had cash of ₹400.9m as well as receivables valued at ₹4.18b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.35b.
Of course, Galaxy Surfactants has a market capitalization of ₹58.5b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Galaxy Surfactants's net debt is only 0.70 times its EBITDA. And its EBIT easily covers its interest expense, being 20.1 times the size. So we're pretty relaxed about its super-conservative use of debt. The good news is that Galaxy Surfactants has increased its EBIT by 8.9% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Galaxy Surfactants'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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Galaxy Surfactants's free cash flow amounted to 39% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Our View
Galaxy Surfactants's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Taking all this data into account, it seems to us that Galaxy Surfactants takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. Over time, share prices tend to follow earnings per share, so if you're interested in Galaxy Surfactants, 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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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