We Think Gujarat Alkalies and Chemicals (NSE:GUJALKALI) Can Stay On Top Of Its Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Gujarat Alkalies and Chemicals Limited (NSE:GUJALKALI) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Gujarat Alkalies and Chemicals

What Is Gujarat Alkalies and Chemicals's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Gujarat Alkalies and Chemicals had ₹5.93b of debt, an increase on ₹4.97b, over one year. However, it also had ₹3.22b in cash, and so its net debt is ₹2.71b.

A Look At Gujarat Alkalies and Chemicals' Liabilities

According to the last reported balance sheet, Gujarat Alkalies and Chemicals had liabilities of ₹7.35b due within 12 months, and liabilities of ₹13.4b due beyond 12 months. Offsetting these obligations, it had cash of ₹3.22b as well as receivables valued at ₹3.54b due within 12 months. So its liabilities total ₹14.0b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Gujarat Alkalies and Chemicals is worth ₹53.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Gujarat Alkalies and Chemicals has a low net debt to EBITDA ratio of only 0.27. And its EBIT easily covers its interest expense, being 128 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Gujarat Alkalies and Chemicals grew its EBIT by 328% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is Gujarat Alkalies and Chemicals's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Gujarat Alkalies and Chemicals saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

The good news is that Gujarat Alkalies and Chemicals's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Gujarat Alkalies and Chemicals can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Gujarat Alkalies and Chemicals (including 1 which makes us a bit uncomfortable) .

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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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.