Gujarat Industries Power (NSE:GIPCL) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Gujarat Industries Power Company Limited (NSE:GIPCL) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Gujarat Industries Power

What Is Gujarat Industries Power's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Gujarat Industries Power had ₹3.85b of debt in September 2020, down from ₹4.47b, one year before. However, it does have ₹5.44b in cash offsetting this, leading to net cash of ₹1.59b.

How Healthy Is Gujarat Industries Power's Balance Sheet?

According to the last reported balance sheet, Gujarat Industries Power had liabilities of ₹2.53b due within 12 months, and liabilities of ₹9.43b due beyond 12 months. Offsetting these obligations, it had cash of ₹5.44b as well as receivables valued at ₹1.01b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹5.50b.

This deficit isn't so bad because Gujarat Industries Power is worth ₹12.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Gujarat Industries Power also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Gujarat Industries Power has seen its EBIT plunge 12% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Gujarat Industries Power will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Gujarat Industries Power has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Gujarat Industries Power generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

Although Gujarat Industries Power's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹1.59b. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in ₹2.5b. So we don't have any problem with Gujarat Industries Power's use of debt. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Gujarat Industries Power's dividend history, without delay!

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.

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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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