Gujarat Alkalies and Chemicals (NSE:GUJALKALI) Seems To Use Debt Quite Sensibly

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. We note that Gujarat Alkalies and Chemicals Limited (NSE:GUJALKALI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Gujarat Alkalies and Chemicals

How Much Debt Does Gujarat Alkalies and Chemicals Carry?

You can click the graphic below for the historical numbers, but it shows that Gujarat Alkalies and Chemicals had ₹1.10b of debt in September 2020, down from ₹1.61b, one year before. But on the other hand it also has ₹3.67b in cash, leading to a ₹2.57b net cash position.

A Look At Gujarat Alkalies and Chemicals' Liabilities

The latest balance sheet data shows that Gujarat Alkalies and Chemicals had liabilities of ₹6.39b due within a year, and liabilities of ₹7.66b falling due after that. Offsetting these obligations, it had cash of ₹3.67b as well as receivables valued at ₹6.51b due within 12 months. So it has liabilities totalling ₹3.87b more than its cash and near-term receivables, combined.

Since publicly traded Gujarat Alkalies and Chemicals shares are worth a total of ₹26.1b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Gujarat Alkalies and Chemicals also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Gujarat Alkalies and Chemicals's load is not too heavy, because its EBIT was down 73% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Gujarat Alkalies and Chemicals's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Gujarat Alkalies and Chemicals 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. Looking at the most recent three years, Gujarat Alkalies and Chemicals recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Gujarat Alkalies and Chemicals's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹2.57b. So we don't have any problem with Gujarat Alkalies and Chemicals's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Gujarat Alkalies and Chemicals that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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