We Think Geodrill (TSE:GEO) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Geodrill

How Much Debt Does Geodrill Carry?

As you can see below, at the end of September 2021, Geodrill had US$10.3m of debt, up from US$2.08m a year ago. Click the image for more detail. But on the other hand it also has US$19.4m in cash, leading to a US$9.07m net cash position.

How Strong Is Geodrill's Balance Sheet?

According to the last reported balance sheet, Geodrill had liabilities of US$28.8m due within 12 months, and liabilities of US$6.24m due beyond 12 months. Offsetting these obligations, it had cash of US$19.4m as well as receivables valued at US$22.7m due within 12 months. So it can boast US$7.03m more liquid assets than total liabilities.

This short term liquidity is a sign that Geodrill could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Geodrill boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Geodrill grew its EBIT by 172% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Geodrill'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 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. Over the last three years, Geodrill reported free cash flow worth 19% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Geodrill has net cash of US$9.07m, as well as more liquid assets than liabilities. And we liked the look of last year's 172% 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 4 warning signs for Geodrill (of which 1 is concerning!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.