Warren Buffett famously said, '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. As with many other companies Gujarat Gas Limited (NSE:GUJGASLTD) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. 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, 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.
See our latest analysis for Gujarat Gas
What Is Gujarat Gas's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Gujarat Gas had ₹1.91b of debt in September 2022, down from ₹5.21b, one year before. But it also has ₹4.05b in cash to offset that, meaning it has ₹2.14b net cash.
How Healthy Is Gujarat Gas' Balance Sheet?
The latest balance sheet data shows that Gujarat Gas had liabilities of ₹25.7b due within a year, and liabilities of ₹12.2b falling due after that. On the other hand, it had cash of ₹4.05b and ₹8.94b worth of receivables due within a year. So its liabilities total ₹24.9b more than the combination of its cash and short-term receivables.
Since publicly traded Gujarat Gas shares are worth a total of ₹322.0b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Gujarat Gas also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the other side of the story is that Gujarat Gas saw its EBIT decline by 8.5% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Gujarat Gas'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Gujarat Gas 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. In the last three years, Gujarat Gas's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
We could understand if investors are concerned about Gujarat Gas's liabilities, but we can be reassured by the fact it has has net cash of ₹2.14b. So we are not troubled with Gujarat Gas's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Gujarat Gas is showing 3 warning signs in our investment analysis , you should know about...
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
About NSEI:GUJGASLTD
Excellent balance sheet second-rate dividend payer.