We Think G8 Education (ASX:GEM) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that G8 Education Limited (ASX:GEM) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for G8 Education

How Much Debt Does G8 Education Carry?

The image below, which you can click on for greater detail, shows that G8 Education had debt of AU$94.9m at the end of June 2021, a reduction from AU$293.9m over a year. But on the other hand it also has AU$106.5m in cash, leading to a AU$11.6m net cash position.

How Strong Is G8 Education's Balance Sheet?

We can see from the most recent balance sheet that G8 Education had liabilities of AU$265.3m falling due within a year, and liabilities of AU$704.5m due beyond that. On the other hand, it had cash of AU$106.5m and AU$18.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$844.6m.

This deficit is considerable relative to its market capitalization of AU$1.01b, so it does suggest shareholders should keep an eye on G8 Education's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, G8 Education also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is well worth noting that G8 Education's EBIT shot up like bamboo after rain, gaining 46% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine G8 Education's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While G8 Education has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, G8 Education recorded free cash flow worth a fulsome 89% 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

Although G8 Education's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$11.6m. And it impressed us with free cash flow of AU$147m, being 89% of its EBIT. So we don't have any problem with G8 Education's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - G8 Education has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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