These 4 Measures Indicate That Power Grid Corporation of India (NSE:POWERGRID) Is Using Debt Reasonably Well

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.' 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 Power Grid Corporation of India Limited (NSE:POWERGRID) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Power Grid Corporation of India

What Is Power Grid Corporation of India's Debt?

The chart below, which you can click on for greater detail, shows that Power Grid Corporation of India had ₹1.27t in debt in March 2024; about the same as the year before. However, because it has a cash reserve of ₹81.0b, its net debt is less, at about ₹1.19t.

How Healthy Is Power Grid Corporation of India's Balance Sheet?

The latest balance sheet data shows that Power Grid Corporation of India had liabilities of ₹344.2b due within a year, and liabilities of ₹1.29t falling due after that. Offsetting these obligations, it had cash of ₹81.0b as well as receivables valued at ₹116.7b due within 12 months. So its liabilities total ₹1.44t more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Power Grid Corporation of India has a huge market capitalization of ₹3.08t, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Power Grid Corporation of India's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 3.1 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Power Grid Corporation of India's EBIT was pretty flat over the last year, which isn't ideal given the debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Power Grid Corporation of India's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Power Grid Corporation of India recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

On our analysis Power Grid Corporation of India's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. We would also note that Electric Utilities industry companies like Power Grid Corporation of India commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Power Grid Corporation of India is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Power Grid Corporation of India is showing 2 warning signs in our investment analysis , you should know about...

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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