GUD Holdings (ASX:GUD) Seems To Use Debt Rather Sparingly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that GUD Holdings Limited (ASX:GUD) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for GUD Holdings

How Much Debt Does GUD Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2021 GUD Holdings had debt of AU$566.1m, up from AU$152.9m in one year. However, its balance sheet shows it holds AU$734.9m in cash, so it actually has AU$168.9m net cash.

How Healthy Is GUD Holdings' Balance Sheet?

According to the last reported balance sheet, GUD Holdings had liabilities of AU$171.2m due within 12 months, and liabilities of AU$700.1m due beyond 12 months. Offsetting these obligations, it had cash of AU$734.9m as well as receivables valued at AU$153.8m due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that GUD Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the AU$1.73b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that GUD Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that GUD Holdings has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine GUD Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. GUD Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, GUD Holdings produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case GUD Holdings has AU$168.9m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 28% over the last year. So is GUD Holdings's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example GUD Holdings has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.