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

Warren Buffett famously said, '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. We can see that Grasim Industries Limited (NSE:GRASIM) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at 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 2024 Grasim Industries had debt of ₹1.39t, up from ₹1.03t in one year. However, it does have ₹221.2b in cash offsetting this, leading to net debt of about ₹1.17t.

How Healthy Is Grasim Industries' Balance Sheet?

The latest balance sheet data shows that Grasim Industries had liabilities of ₹924.3b due within a year, and liabilities of ₹1.81t falling due after that. Offsetting this, it had ₹221.2b in cash and ₹409.1b in receivables that were due within 12 months. So its liabilities total ₹2.11t more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's huge ₹1.85t market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). 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).

While we wouldn't worry about Grasim Industries's net debt to EBITDA ratio of 4.3, we think its super-low interest cover of 2.4 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. On a lighter note, we note that Grasim Industries grew its EBIT by 29% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. There's no doubt that we learn most about debt from the balance sheet. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Grasim Industries burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Grasim Industries's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, we think it's fair to say that Grasim Industries has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 example, we've discovered 4 warning signs for Grasim Industries (2 are potentially serious!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.