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 synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Gravita India Limited (NSE:GRAVITA) uses debt in its business. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Gravita India
What is Gravita India’s debt?
As you can see below, at the end of March 2022, Gravita India had ₹3.87 billion in debt, up from ₹2.56 billion a year ago. Click on the image for more details. On the other hand, it has ₹325.2 million in cash, resulting in a net debt of around ₹3.55 billion.
How strong is Gravita India’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Gravita India had liabilities of ₹4.69 billion due within 12 months and liabilities of ₹1.28 billion due beyond. As compensation for these obligations, it had cash of ₹325.2 million as well as receivables valued at ₹1.13 billion due within 12 months. It therefore has liabilities totaling ₹4.51 billion more than its cash and short-term receivables, combined.
This shortfall is not that bad as Gravita India is worth ₹17.6 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Gravita India has net debt worth 1.7x EBITDA, which isn’t too much, but its interest coverage looks a little low, with EBIT at just 5.7x expense. interests. While that doesn’t worry us too much, it does suggest that interest payments are a bit of a burden. It should be noted that Gravita India’s EBIT has surged like bamboo after rain, gaining 88% over the last twelve months. This will make it easier to manage your debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Gravita India’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Gravita India has recorded free cash flow of 3.1% of its EBIT, which is really quite low. This low level of cash conversion compromises its ability to manage and repay its debt.
Our point of view
Based on our analysis, Gravita India’s EBIT growth rate should indicate that it won’t have too many problems with its debt. However, our other observations were not so encouraging. To be precise, it seems about as good at converting EBIT to free cash flow as wet socks are at keeping your feet warm. When we consider all the elements mentioned above, it seems to us that Gravita India manages its debt quite well. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that Gravita India shows 4 warning signs in our investment analysis and 2 of them are significant…
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.