Does India Grid Trust (NSE:INDIGRID) Have A Healthy Balance Sheet?

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 note that India Grid Trust (NSE:INDIGRID) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for India Grid Trust

What Is India Grid Trust's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 India Grid Trust had ₹79.0b of debt, an increase on ₹52.1b, over one year. However, because it has a cash reserve of ₹8.38b, its net debt is less, at about ₹70.6b.

How Healthy Is India Grid Trust's Balance Sheet?

The latest balance sheet data shows that India Grid Trust had liabilities of ₹3.02b due within a year, and liabilities of ₹80.0b falling due after that. Offsetting these obligations, it had cash of ₹8.38b as well as receivables valued at ₹3.26b due within 12 months. So its liabilities total ₹71.3b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₹74.7b, so it does suggest shareholders should keep an eye on India Grid Trust's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 5.4 hit our confidence in India Grid Trust like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The good news is that India Grid Trust grew its EBIT a smooth 51% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if India Grid Trust 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, India Grid Trust burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both India Grid Trust's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We should also note that Electric Utilities industry companies like India Grid Trust commonly do use debt without problems. Overall, we think it's fair to say that India Grid Trust has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Be aware that India Grid Trust is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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