Geodrill (TSE:GEO) Has A Pretty Healthy Balance Sheet

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.' 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. Importantly, Geodrill Limited (TSE:GEO) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Geodrill

What Is Geodrill's Net Debt?

As you can see below, Geodrill had US$2.08m of debt at September 2020, down from US$4.92m a year prior. But it also has US$11.7m in cash to offset that, meaning it has US$9.58m net cash.

How Healthy Is Geodrill's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Geodrill had liabilities of US$13.9m due within 12 months and liabilities of US$3.18m due beyond that. Offsetting these obligations, it had cash of US$11.7m as well as receivables valued at US$15.7m due within 12 months. So it actually has US$10.3m more liquid assets than total liabilities.

It's good to see that Geodrill has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Geodrill boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Geodrill if management cannot prevent a repeat of the 53% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Geodrill'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Geodrill 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. In the last three years, Geodrill's free cash flow amounted to 22% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Geodrill has US$9.58m in net cash and a decent-looking balance sheet. So we are not troubled with Geodrill's debt use. 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 - Geodrill 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.

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