Grasim Industries (NSE:GRASIM) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Grasim Industries Limited (NSE:GRASIM) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Grasim Industries

What Is Grasim Industries's Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Grasim Industries had debt of ₹1.03t, up from ₹747.4b in one year. However, it does have ₹181.9b in cash offsetting this, leading to net debt of about ₹848.5b.

A Look At Grasim Industries' Liabilities

According to the last reported balance sheet, Grasim Industries had liabilities of ₹695.3b due within 12 months, and liabilities of ₹1.45t due beyond 12 months. On the other hand, it had cash of ₹181.9b and ₹297.8b worth of receivables due within a year. So its liabilities total ₹1.66t more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's massive market capitalization of ₹1.26t, we think shareholders really should watch Grasim Industries's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Grasim Industries's debt is 3.9 times its EBITDA, and its EBIT cover its interest expense 2.7 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Fortunately, Grasim Industries grew its EBIT by 2.0% in the last year, slowly shrinking its debt relative to earnings. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Grasim Industries'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.

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 last three years, Grasim Industries saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Grasim Industries's level of total liabilities and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think Grasim Industries has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Grasim Industries (2 are a bit concerning) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.