David Iben put it well when he said, âVolatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ 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. We can see that Grasim Industries Limited (NSE: GRASIM) uses debt in its activity. But does this debt concern 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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first consider both liquidity and debt levels.
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What is the net debt of Grasim Industries?
You can click on the graph below for historical figures, but it shows that in March 2021, Grasim Industries had a debt of 790.8 billion yen, an increase from 723.0 billion yen, on a year. However, he also had 219.2 billion yen in cash, so his net debt is 571.6 billion yen.
How strong is Grasim Industries’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Grasim Industries had liabilities of 520.1 billion yen due within 12 months and liabilities of 1.12 tonnes of yen beyond. In compensation for these obligations, he had cash of 219.2 billion euros as well as receivables valued at 210.3 billion euros within 12 months. Its liabilities therefore total 1.22 more than the combination of its cash and short-term receivables.
Given that this deficit is actually greater than the company’s massive market cap of 1.03 ton, we think shareholders should really watch Grasim Industries’ debt levels, like a parent watching their child go crazy. cycling for the first time. Hypothetically, an extremely large dilution would be required if the company was forced to repay its debts by raising capital at the current share price.
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 consider debt versus earnings with and without amortization charges.
Grasim Industries’ debt is 2.8 times its EBITDA, and its EBIT covers its interest expense 3.2 times. This suggests that while debt levels are significant, we would stop calling them problematic. Looking on the bright side, Grasim Industries increased its EBIT by a silky 47% last year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of handling debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Grasim Industries’ ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Grasim Industries has recorded free cash flow of 51% of its EBIT, which is close to normal, as 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 level of total liabilities and interest coverage of Grasim Industries certainly weighs on this, in our opinion. But the good news is that he seems to be able to increase his EBIT with ease. When we consider all the factors mentioned, it seems to us that Grasim Industries is taking risks with its recourse to debt. While this debt may increase returns, we believe the company now has sufficient leverage. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Grasim Industries (1 of which should not be ignored!) that you should know.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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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 shares 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 the mentioned stocks.
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