These 4 metrics indicate that GMM Pfaudler (NSE:GMMPFAUDLR) is using debt reasonably well

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Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies GMM Pfaudler Limited (NSE:GMMPFAUDLR) uses debt. But does this debt worry shareholders?

What risk does debt carry?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for GMM Pfaudler

What is GMM Pfaudler’s debt?

As you can see below, at the end of September 2021, GMM Pfaudler had a debt of ₹5.29 billion, up from ₹405.9 million a year ago. Click on the image for more details. However, since he has a cash reserve of ₹2.80 billion, his net debt is lower at around ₹2.49 billion.

NSEI:GMMPFAUDLR Debt to Equity History January 20, 2022

A look at the responsibilities of GMM Pfaudler

We can see from the most recent balance sheet that GMM Pfaudler had liabilities of ₹8.90 billion due within a year, and liabilities of ₹10.8 billion due beyond. As compensation for these obligations, it had cash of ₹2.80 billion as well as receivables valued at ₹2.93 billion due within 12 months. It therefore has liabilities totaling ₹14.0 billion more than its cash and short-term receivables, combined.

Considering that GMM Pfaudler has a market capitalization of ₹71.1 billion, it is hard to believe that these liabilities pose a big threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.

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 ).

GMM Pfaudler’s net debt is only 0.88 times its EBITDA. And its EBIT covers its interest charges 10.1 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, we are pleased to report that GMM Pfaudler increased its EBIT by 83%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine GMM Pfaudler’s 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, a company can only repay its debts with cash, not book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, GMM Pfaudler has recorded free cash flow of 23% of its EBIT, which is lower than expected. It’s not great when it comes to paying off debt.

Our point of view

The good news is that GMM Pfaudler’s demonstrated ability to increase EBIT delights us like a fluffy puppy does a toddler. But, on a darker note, we are a bit concerned about its conversion of EBIT into free cash flow. Given all of this data, it seems to us that GMM Pfaudler is taking a pretty sensible approach to debt. While this carries some risk, it can also improve shareholder returns. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for GMM Pfaudler you should know.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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.

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