David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, GP Petroleums Limited (NSE: GULFPETRO) is in debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for GP Petroleums
What is GP Petroleums’ net debt?
As you can see below, GP Petroleums had a debt of ₹316.5 million in March 2022, up from ₹1.18 billion the previous year. Net debt is about the same, since she doesn’t have a lot of cash.
A look at the responsibilities of GP Petroleums
According to the latest published balance sheet, GP Petroleums had liabilities of ₹652.1 million due within 12 months and liabilities of ₹70.2 million due beyond 12 months. As compensation for these obligations, it had cash of ₹2.79 million as well as receivables valued at ₹1.10 billion and due within 12 months. He can therefore boast of having ₹376.1 million in liquid assets more than total Passives.
This excess liquidity suggests that GP Petroleums is taking a cautious approach to debt. Because he has a lot of assets, he is unlikely to have any problems with his lenders.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). 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 ).
GP Petroleums has a low net debt to EBITDA ratio of just 1.1. And its EBIT easily covers its interest charges, which is 31.7 times the size. So we’re pretty relaxed about his super-conservative use of debt. Another good thing is that GP Petroleums increased its EBIT by 13% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since GP Petroleums will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, GP Petroleums has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
GP Petroleums’ interest cover suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news does not stop there, since its conversion of EBIT into free cash flow also confirms this impression! Given this set of factors, we believe that GP Petroleums is quite cautious with its debt, and the risks seem well controlled. The balance sheet therefore seems rather healthy to us. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. We have identified 2 warning signs with GP Petroleums (at least 1, which is significant), and understanding them should be part of your investment process.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings 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 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.