These 4 Measures Indicate That GAIL (India) (NSE:GAIL) Is Using Debt Reasonably Well

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.' 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. Importantly, GAIL (India) Limited (NSE:GAIL) does carry 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. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for GAIL (India)

How Much Debt Does GAIL (India) Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 GAIL (India) had ₹168.6b of debt, an increase on ₹162.0b, over one year. However, because it has a cash reserve of ₹32.0b, its net debt is less, at about ₹136.6b.

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

The latest balance sheet data shows that GAIL (India) had liabilities of ₹198.0b due within a year, and liabilities of ₹251.7b falling due after that. Offsetting these obligations, it had cash of ₹32.0b as well as receivables valued at ₹103.3b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹314.4b.

While this might seem like a lot, it is not so bad since GAIL (India) has a huge market capitalization of ₹1.31t, 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). 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).

GAIL (India)'s net debt is only 0.83 times its EBITDA. And its EBIT covers its interest expense a whopping 17.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, GAIL (India) grew its EBIT by 183% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. 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 we always check how much of that EBIT is translated into free cash flow. In the last three years, GAIL (India) created free cash flow amounting to 5.0% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

The good news is that GAIL (India)'s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. We would also note that Gas Utilities industry companies like GAIL (India) commonly do use debt without problems. Taking all this data into account, it seems to us that GAIL (India) takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that GAIL (India) is showing 1 warning sign in our investment analysis , you should know about...

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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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.