These 4 Measures Indicate That Gujarat State Petronet (NSE:GSPL) Is Using Debt Safely

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. Importantly, Gujarat State Petronet Limited (NSE:GSPL) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Net Debt?

As you can see below, Gujarat State Petronet had ₹15.2b of debt at March 2021, down from ₹23.8b a year prior. However, it also had ₹4.96b in cash, and so its net debt is ₹10.2b.

How Strong Is Gujarat State Petronet's Balance Sheet?

According to the last reported balance sheet, Gujarat State Petronet had liabilities of ₹31.1b due within 12 months, and liabilities of ₹26.0b due beyond 12 months. Offsetting these obligations, it had cash of ₹4.96b as well as receivables valued at ₹9.10b due within 12 months. So it has liabilities totalling ₹43.0b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Gujarat State Petronet is worth ₹178.5b, 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.

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 0.25. And its EBIT covers its interest expense a whopping 18.9 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Gujarat State Petronet has boosted its EBIT by 52%, thus reducing the spectre of future debt repayments. 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 68% 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 that's just the beginning of the good news since its EBIT growth rate is also very heartening. We would also note that Gas Utilities industry companies like Gujarat State Petronet commonly do use debt without problems. Overall, we don't think Gujarat State Petronet is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. 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. Case in point: We've spotted 1 warning sign for Gujarat State Petronet you should be aware of.

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.
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