Is Geodrill (TSE:GEO) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Geodrill Limited (TSE:GEO) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Geodrill

How Much Debt Does Geodrill Carry?

You can click the graphic below for the historical numbers, but it shows that Geodrill had US$4.61m of debt in December 2022, down from US$6.90m, one year before. However, its balance sheet shows it holds US$15.1m in cash, so it actually has US$10.5m net cash.

How Healthy Is Geodrill's Balance Sheet?

We can see from the most recent balance sheet that Geodrill had liabilities of US$28.3m falling due within a year, and liabilities of US$5.84m due beyond that. Offsetting this, it had US$15.1m in cash and US$34.3m in receivables that were due within 12 months. So it actually has US$15.2m more liquid assets than total liabilities.

This surplus suggests that Geodrill has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Geodrill has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Geodrill has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Geodrill can strengthen its balance sheet over time. 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. While Geodrill 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. In the last three years, Geodrill created free cash flow amounting to 10% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Geodrill has net cash of US$10.5m, as well as more liquid assets than liabilities. And we liked the look of last year's 49% year-on-year EBIT growth. So we don't think Geodrill's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Geodrill 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.