These 4 Measures Indicate That Godawari Power & Ispat (NSE:GPIL) Is Using Debt Safely

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Godawari Power & Ispat Limited (NSE:GPIL) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Godawari Power & Ispat

How Much Debt Does Godawari Power & Ispat Carry?

The image below, which you can click on for greater detail, shows that Godawari Power & Ispat had debt of ₹4.69b at the end of September 2021, a reduction from ₹14.3b over a year. However, it does have ₹803.9m in cash offsetting this, leading to net debt of about ₹3.89b.

A Look At Godawari Power & Ispat's Liabilities

According to the last reported balance sheet, Godawari Power & Ispat had liabilities of ₹5.43b due within 12 months, and liabilities of ₹5.37b due beyond 12 months. Offsetting this, it had ₹803.9m in cash and ₹2.51b in receivables that were due within 12 months. So its liabilities total ₹7.48b more than the combination of its cash and short-term receivables.

Of course, Godawari Power & Ispat has a market capitalization of ₹49.5b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Godawari Power & Ispat's net debt is only 0.19 times its EBITDA. And its EBIT easily covers its interest expense, being 30.7 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, Godawari Power & Ispat grew its EBIT by 151% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Godawari Power & 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Godawari Power & Ispat recorded free cash flow worth 74% 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

Godawari Power & Ispat'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 that's just the beginning of the good news since its EBIT growth rate is also very heartening. Considering this range of factors, it seems to us that Godawari Power & Ispat is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Godawari Power & Ispat 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.

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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.