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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Gujarat Industries Power Company Limited (NSE:GIPCL) does carry debt. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Gujarat Industries Power
What Is Gujarat Industries Power's Net Debt?
The image below, which you can click on for greater detail, shows that Gujarat Industries Power had debt of ₹5.73b at the end of March 2019, a reduction from ₹6.17b over a year. However, it does have ₹2.61b in cash offsetting this, leading to net debt of about ₹3.12b.
How Healthy Is Gujarat Industries Power's Balance Sheet?
According to the last reported balance sheet, Gujarat Industries Power had liabilities of ₹4.38b due within 12 months, and liabilities of ₹8.23b due beyond 12 months. On the other hand, it had cash of ₹2.61b and ₹2.28b worth of receivables due within a year. So its liabilities total ₹7.72b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of ₹10.3b. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.