Stock Analysis

Gale Pacific (ASX:GAP) Has A Rock Solid Balance Sheet

ASX:GAP
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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.' 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, Gale Pacific Limited (ASX:GAP) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Gale Pacific

How Much Debt Does Gale Pacific Carry?

You can click the graphic below for the historical numbers, but it shows that Gale Pacific had AU$28.9m of debt in June 2021, down from AU$43.1m, one year before. However, it does have AU$30.4m in cash offsetting this, leading to net cash of AU$1.47m.

debt-equity-history-analysis
ASX:GAP Debt to Equity History October 22nd 2021

How Healthy Is Gale Pacific's Balance Sheet?

We can see from the most recent balance sheet that Gale Pacific had liabilities of AU$60.5m falling due within a year, and liabilities of AU$35.0m due beyond that. Offsetting these obligations, it had cash of AU$30.4m as well as receivables valued at AU$41.5m due within 12 months. So it has liabilities totalling AU$23.6m more than its cash and near-term receivables, combined.

Since publicly traded Gale Pacific shares are worth a total of AU$118.6m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Gale Pacific boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Gale Pacific grew its EBIT by 174% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Gale Pacific's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Gale Pacific 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. Over the last three years, Gale Pacific recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While Gale Pacific does have more liabilities than liquid assets, it also has net cash of AU$1.47m. And it impressed us with free cash flow of AU$31m, being 95% of its EBIT. So we don't think Gale Pacific's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Gale Pacific you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Valuation is complex, but we're helping make it simple.

Find out whether Gale Pacific is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.

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