Is Gabriel Holding (CPH:GABR) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Gabriel Holding A/S (CPH:GABR) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Gabriel Holding

What Is Gabriel Holding's Debt?

As you can see below, at the end of March 2023, Gabriel Holding had kr.410.2m of debt, up from kr.302.6m a year ago. Click the image for more detail. However, because it has a cash reserve of kr.59.4m, its net debt is less, at about kr.350.8m.

How Healthy Is Gabriel Holding's Balance Sheet?

According to the last reported balance sheet, Gabriel Holding had liabilities of kr.422.8m due within 12 months, and liabilities of kr.73.8m due beyond 12 months. Offsetting these obligations, it had cash of kr.59.4m as well as receivables valued at kr.158.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.279.0m.

This deficit isn't so bad because Gabriel Holding is worth kr.638.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.99 times and a disturbingly high net debt to EBITDA ratio of 7.6 hit our confidence in Gabriel Holding like a one-two punch to the gut. The debt burden here is substantial. Worse, Gabriel Holding's EBIT was down 70% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Gabriel Holding's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Gabriel Holding saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Gabriel Holding's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. Taking into account all the aforementioned factors, it looks like Gabriel Holding has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Gabriel Holding (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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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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.