Galaxy Surfactants (NSE:GALAXYSURF) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Galaxy Surfactants Limited (NSE:GALAXYSURF) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Galaxy Surfactants

What Is Galaxy Surfactants's Net Debt?

The image below, which you can click on for greater detail, shows that Galaxy Surfactants had debt of ₹2.73b at the end of March 2021, a reduction from ₹3.72b over a year. However, it does have ₹1.60b in cash offsetting this, leading to net debt of about ₹1.13b.

How Strong Is Galaxy Surfactants' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Galaxy Surfactants had liabilities of ₹6.20b due within 12 months and liabilities of ₹1.28b due beyond that. Offsetting these obligations, it had cash of ₹1.60b as well as receivables valued at ₹4.69b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.18b.

Having regard to Galaxy Surfactants' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹113.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Galaxy Surfactants has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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).

Galaxy Surfactants's net debt is only 0.25 times its EBITDA. And its EBIT covers its interest expense a whopping 27.9 times over. So we're pretty relaxed about its super-conservative use of debt. Also positive, Galaxy Surfactants grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. 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 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Galaxy Surfactants produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Galaxy Surfactants's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Looking at the bigger picture, we think Galaxy Surfactants's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 - Galaxy Surfactants has 1 warning sign we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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