Is Gujarat State Petronet (NSE:GSPL) A Risky Investment?

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. We can see that Gujarat State Petronet Limited (NSE:GSPL) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Gujarat State Petronet

What Is Gujarat State Petronet's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Gujarat State Petronet had ₹7.13b of debt in March 2022, down from ₹15.2b, one year before. However, it does have ₹1.35b in cash offsetting this, leading to net debt of about ₹5.78b.

How Healthy Is Gujarat State Petronet's Balance Sheet?

The latest balance sheet data shows that Gujarat State Petronet had liabilities of ₹28.2b due within a year, and liabilities of ₹19.6b falling due after that. Offsetting this, it had ₹1.35b in cash and ₹10.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹36.0b.

This deficit isn't so bad because Gujarat State Petronet is worth ₹142.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Gujarat State Petronet has a low net debt to EBITDA ratio of only 0.17. And its EBIT easily covers its interest expense, being 28.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Gujarat State Petronet if management cannot prevent a repeat of the 23% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Gujarat State Petronet's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. During the last three years, Gujarat State Petronet produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Gujarat State Petronet's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. We would also note that Gas Utilities industry companies like Gujarat State Petronet commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Gujarat State Petronet is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Gujarat State Petronet 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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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.