Is Granules India (NSE:GRANULES) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Granules India Limited (NSE:GRANULES) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Granules India

What Is Granules India's Net Debt?

As you can see below, Granules India had ₹7.42b of debt at March 2021, down from ₹8.84b a year prior. However, it also had ₹2.71b in cash, and so its net debt is ₹4.71b.

A Look At Granules India's Liabilities

Zooming in on the latest balance sheet data, we can see that Granules India had liabilities of ₹11.7b due within 12 months and liabilities of ₹3.67b due beyond that. Offsetting this, it had ₹2.71b in cash and ₹7.76b in receivables that were due within 12 months. So its liabilities total ₹4.93b more than the combination of its cash and short-term receivables.

Of course, Granules India has a market capitalization of ₹82.3b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Granules India has a low net debt to EBITDA ratio of only 0.55. And its EBIT easily covers its interest expense, being 26.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Granules India grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. 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 Granules India's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Granules India's free cash flow amounted to 31% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Granules India's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Looking at the bigger picture, we think Granules India's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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 Granules India that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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