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. 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. We can see that Gallantt Ispat Limited (NSE:GALLISPAT) does use debt in its business. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Gallantt Ispat
How Much Debt Does Gallantt Ispat Carry?
The chart below, which you can click on for greater detail, shows that Gallantt Ispat had ₹2.42b in debt in September 2019; about the same as the year before. But it also has ₹2.48b in cash to offset that, meaning it has ₹59.2m net cash.
How Healthy Is Gallantt Ispat's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Gallantt Ispat had liabilities of ₹1.56b due within 12 months and liabilities of ₹1.26b due beyond that. Offsetting these obligations, it had cash of ₹2.48b as well as receivables valued at ₹615.1m due within 12 months. So it actually has ₹268.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Gallantt Ispat could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Gallantt Ispat has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Gallantt Ispat's load is not too heavy, because its EBIT was down 60% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Ispat will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Gallantt Ispat may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Gallantt Ispat recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
Summing up
While it is always sensible to investigate a company's debt, in this case Gallantt Ispat has ₹59.2m in net cash and a decent-looking balance sheet. So while Gallantt Ispat does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Gallantt Ispat is showing 4 warning signs in our investment analysis , you should know about...
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.