Warren Buffett famously said, '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. We note that CGI Inc. (TSE:GIB.A) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is CGI's Net Debt?
You can click the graphic below for the historical numbers, but it shows that CGI had CA$3.11b of debt in December 2021, down from CA$3.51b, one year before. On the flip side, it has CA$1.19b in cash leading to net debt of about CA$1.92b.
How Healthy Is CGI's Balance Sheet?
We can see from the most recent balance sheet that CGI had liabilities of CA$3.58b falling due within a year, and liabilities of CA$4.15b due beyond that. On the other hand, it had cash of CA$1.19b and CA$2.35b worth of receivables due within a year. So it has liabilities totalling CA$4.20b more than its cash and near-term receivables, combined.
Since publicly traded CGI shares are worth a very impressive total of CA$24.3b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
CGI has a low net debt to EBITDA ratio of only 0.89. And its EBIT easily covers its interest expense, being 20.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, CGI grew its EBIT by 4.3% in the last year, making that debt load look even more manageable. 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 CGI can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, CGI recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
The good news is that CGI's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, CGI seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. Case in point: We've spotted 1 warning sign for CGI you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
CGI Inc., together with its subsidiaries, provides information technology (IT) and business process services in Canada; Western, Southern, Central, and Eastern Europe; Australia; Scandinavia; Finland, Poland, and Baltics; the United States; the United Kingdom; and the Asia Pacific.
Excellent balance sheet and fair value.