Is Gallantt Metal (NSE:GALLANTT) Using Too Much Debt?

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.' 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. We note that Gallantt Metal Limited (NSE:GALLANTT) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Gallantt Metal

What Is Gallantt Metal's Net Debt?

The image below, which you can click on for greater detail, shows that Gallantt Metal had debt of ₹995.0m at the end of September 2020, a reduction from ₹1.09b over a year. However, because it has a cash reserve of ₹27.0m, its net debt is less, at about ₹968.0m.

How Strong Is Gallantt Metal's Balance Sheet?

The latest balance sheet data shows that Gallantt Metal had liabilities of ₹744.6m due within a year, and liabilities of ₹641.0m falling due after that. On the other hand, it had cash of ₹27.0m and ₹288.6m worth of receivables due within a year. So its liabilities total ₹1.07b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Gallantt Metal has a market capitalization of ₹3.87b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Gallantt Metal has a low net debt to EBITDA ratio of only 1.3. And its EBIT covers its interest expense a whopping 10.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Gallantt Metal grew its EBIT by 131% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Gallantt Metal will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Gallantt Metal saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Gallantt Metal's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to grow its EBIT is pretty flash. Considering this range of data points, we think Gallantt Metal is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Gallantt Metal (1 is significant!) that you should be aware of before investing here.

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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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. 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.
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