Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Above all, Godrej Consumer Products Limited (NSE: GODREJCP) is in debt. But does this debt worry shareholders?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
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What is the debt of Godrej Consumer Products?
As you can see below, at the end of September 2021, Godrej Consumer Products had 21.3 billion yen in debt, up from 11.9 billion yen a year ago. Click on the image for more details. On the other hand, it has 16.8 billion yen in cash, resulting in net debt of around 4.53 billion yen.
How healthy is Godrej Consumer Products’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Godrej Consumer Products had liabilities of 41.6 billion yen owed within 12 months and liabilities of 6.00 billion yen beyond. On the other hand, he had 16.8 billion yen in cash and 10.4 billion yen in receivables due within a year. Its liabilities are therefore 20.3 billion euros more than the combination of its cash and short-term receivables.
Considering that the publicly listed shares of Godrej Consumer Products are worth a very impressive total of 979.2 billion yen, it seems unlikely that this level of liabilities will be a major threat. Having said that, it is clear that we must continue to monitor his record lest it get worse. But in any case, Godrej Consumer Products has virtually no net debt, so it’s fair to say that she doesn’t have a lot of debt!
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we look at debt versus earnings with and without amortization expenses.
Godrej Consumer Products’ net debt is only 0.18 times its EBITDA. And its EBIT easily covers its interest costs, being 71.8 times higher. So we’re pretty relaxed about its ultra-conservative use of debt. And we also warmly note that Godrej Consumer Products increased their EBIT by 15% last year, which makes their debt more manageable. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, the company’s future profitability will decide whether Godrej Consumer Products can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Godrej Consumer Products has recorded free cash flow of 72% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
The good news is that Godrej Consumer Products’ demonstrated ability to cover their interest costs with their EBIT delights us like a fluffy puppy does a toddler. And the good news does not end there, since its net debt to EBITDA also supports this impression! Overall, we don’t think Godrej Consumer Products is taking bad risks as its debt load appears modest. We are therefore not worried about the use of a small leverage on the balance sheet. Another factor that would give us confidence in Godrej Consumer Products would be if insiders bought shares: if you are also aware of this signal, you can find out instantly by clicking on this link.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.