GRP (NSE:GRPLTD) takes some risk with its use of debt

Warren Buffett said: “Volatility is far from synonymous with risk. 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. We can see that GRP Limited (NSE:GRPLTD) uses debt in its business. But the real question is whether this debt makes the business risky.

Why is debt risky?

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. If things go really bad, lenders can take over the business. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.

Check out our latest analysis for GRP

How much debt does the GRP support?

As you can see below, at the end of March 2022, GRP had a debt of ₹996.7 million, up from ₹710.9 million a year ago. Click on the image for more details. However, he also had ₹155.8 million in cash, and hence his net debt is ₹840.9 million.

NSEI:GRPLTD Debt to Equity July 9, 2022

How healthy is the GRP balance sheet?

The latest balance sheet data shows that GRP had liabilities of ₹1.13 billion due within a year, and liabilities of ₹468.9 million falling due thereafter. In return, he had ₹155.8 million in cash and ₹868.5 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of ₹571.0 million.

While that might sound like a lot, it’s not that bad since GRP has a market capitalization of ₹1.95 billion, and so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

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 ).

While GRP’s debt to EBITDA ratio (3.6) suggests it uses some debt, its interest coverage is very low at 2.4, suggesting high leverage. This is largely due to the company’s large amortization charges, which no doubt means that its EBITDA is a very generous measure of earnings, and that its debt may be heavier than it first appears. on board. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. The silver lining is that GRP grew its EBIT by 1,096% last year, which feeds like youthful idealism. If he can keep walking on this path, he will be able to get rid of his debt with relative ease. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since GRP 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 must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past two years, GRP has had negative free cash flow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders must hope that past spending will produce free cash flow in the future.

Our point of view

Neither GRP’s ability to convert EBIT to free cash flow nor its interest coverage gave us confidence in its ability to take on more debt. But the good news is that it looks like it could easily increase its EBIT. We think GRP’s debt makes it a bit risky, after looking at the aforementioned data points together. This isn’t necessarily a bad thing, since leverage can increase return on equity, but it is something to be aware of. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that GRP displays 4 warning signs in our investment analysis and 2 of them are potentially serious…

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.

About Myra R.

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