Is I G Petrochemicals (NSE:IGPL) Using Too Much Debt?

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. Importantly, I G Petrochemicals Limited (NSE:IGPL) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 I G Petrochemicals

How Much Debt Does I G Petrochemicals Carry?

The chart below, which you can click on for greater detail, shows that I G Petrochemicals had ₹2.20b in debt in September 2020; about the same as the year before. However, because it has a cash reserve of ₹630.2m, its net debt is less, at about ₹1.57b.

How Healthy Is I G Petrochemicals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that I G Petrochemicals had liabilities of ₹2.62b due within 12 months and liabilities of ₹2.26b due beyond that. On the other hand, it had cash of ₹630.2m and ₹1.18b worth of receivables due within a year. So its liabilities total ₹3.07b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since I G Petrochemicals has a market capitalization of ₹14.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

I G Petrochemicals's net debt is only 0.92 times its EBITDA. And its EBIT easily covers its interest expense, being 14.1 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, I G Petrochemicals grew its EBIT by 133% 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 I G Petrochemicals will need earnings to service that debt. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, I G Petrochemicals 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

Based on what we've seen I G Petrochemicals is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Considering this range of data points, we think I G Petrochemicals is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for I G Petrochemicals you should know about.

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. 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.
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