Does Gesco (ETR:GSC1) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Gesco AG (ETR:GSC1) 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Gesco

How Much Debt Does Gesco Carry?

As you can see below, Gesco had €76.8m of debt at March 2022, down from €80.1m a year prior. However, it does have €42.8m in cash offsetting this, leading to net debt of about €34.0m.

How Strong Is Gesco's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gesco had liabilities of €144.2m due within 12 months and liabilities of €65.5m due beyond that. Offsetting this, it had €42.8m in cash and €84.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €82.8m.

Gesco has a market capitalization of €248.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Gesco has a low net debt to EBITDA ratio of only 0.53. And its EBIT covers its interest expense a whopping 127 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, Gesco grew its EBIT by 172% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Gesco'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Gesco actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Gesco's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Considering this range of factors, it seems to us that Gesco is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. 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. We've identified 1 warning sign with Gesco , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.