Does GAIL (India) (NSE:GAIL) Have A Healthy Balance Sheet?

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. As with many other companies GAIL (India) Limited (NSE:GAIL) makes use of debt. But should shareholders be worried about its use of debt?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for GAIL (India)

What Is GAIL (India)'s Debt?

As you can see below, at the end of March 2023, GAIL (India) had ₹162.7b of debt, up from ₹78.3b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹11.0b, its net debt is less, at about ₹151.7b.

How Strong Is GAIL (India)'s Balance Sheet?

We can see from the most recent balance sheet that GAIL (India) had liabilities of ₹217.1b falling due within a year, and liabilities of ₹209.6b due beyond that. Offsetting this, it had ₹11.0b in cash and ₹107.5b in receivables that were due within 12 months. So it has liabilities totalling ₹308.2b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since GAIL (India) has a market capitalization of ₹689.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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

GAIL (India)'s net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its commanding EBIT of 13.1 times its interest expense, implies the debt load is as light as a peacock feather. Shareholders should be aware that GAIL (India)'s EBIT was down 63% 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 ultimately the future profitability of the business will decide if GAIL (India) can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, GAIL (India) barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

Mulling over GAIL (India)'s attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We should also note that Gas Utilities industry companies like GAIL (India) commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that GAIL (India)'s debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For example, we've discovered 2 warning signs for GAIL (India) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.