We Think GTPL Hathway (NSE:GTPL) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, GTPL Hathway Limited (NSE:GTPL) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for GTPL Hathway

What Is GTPL Hathway's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 GTPL Hathway had ₹3.25b of debt, an increase on ₹2.39b, over one year. However, because it has a cash reserve of ₹1.37b, its net debt is less, at about ₹1.88b.

How Healthy Is GTPL Hathway's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that GTPL Hathway had liabilities of ₹19.9b due within 12 months and liabilities of ₹1.89b due beyond that. On the other hand, it had cash of ₹1.37b and ₹8.01b worth of receivables due within a year. So it has liabilities totalling ₹12.4b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's ₹12.2b market capitalization, you might well be inclined to review the balance sheet intently. 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 0.53 and interest cover of 4.2 times, it seems to us that GTPL Hathway is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Shareholders should be aware that GTPL Hathway's EBIT was down 50% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is GTPL Hathway'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 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, GTPL Hathway reported free cash flow worth 19% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Mulling over GTPL Hathway's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. We're quite clear that we consider GTPL Hathway to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for GTPL Hathway you should be aware of, and 1 of them is concerning.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.