Is Gujarat State Petronet (NSE:GSPL) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Gujarat State Petronet Limited (NSE:GSPL) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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.

View our latest analysis for Gujarat State Petronet

What Is Gujarat State Petronet's Debt?

You can click the graphic below for the historical numbers, but it shows that Gujarat State Petronet had ₹14.6b of debt in March 2021, down from ₹36.3b, one year before. However, it does have ₹4.96b in cash offsetting this, leading to net debt of about ₹9.59b.

A Look At Gujarat State Petronet's Liabilities

Zooming in on the latest balance sheet data, we can see that Gujarat State Petronet had liabilities of ₹31.1b due within 12 months and liabilities of ₹26.0b due beyond that. Offsetting this, it had ₹4.96b in cash and ₹9.09b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹43.0b.

This deficit isn't so bad because Gujarat State Petronet is worth ₹172.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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 0.27. And its EBIT covers its interest expense a whopping 13.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Gujarat State Petronet grew its EBIT at 10% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Gujarat State Petronet 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. During the last three years, Gujarat State Petronet produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Gujarat State Petronet's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! We would also note that Gas Utilities industry companies like Gujarat State Petronet commonly do use debt without problems. Looking at the bigger picture, we think Gujarat State Petronet's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Gujarat State Petronet insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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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