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.' 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. As with many other companies Gaztransport & Technigaz SA (EPA:GTT) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Gaztransport & Technigaz Carry?
You can click the graphic below for the historical numbers, but it shows that Gaztransport & Technigaz had €2.69m of debt in June 2021, down from €4.68m, one year before. However, it does have €164.3m in cash offsetting this, leading to net cash of €161.6m.
A Look At Gaztransport & Technigaz's Liabilities
According to the last reported balance sheet, Gaztransport & Technigaz had liabilities of €119.4m due within 12 months, and liabilities of €19.4m due beyond 12 months. On the other hand, it had cash of €164.3m and €121.5m worth of receivables due within a year. So it actually has €147.0m more liquid assets than total liabilities.
This short term liquidity is a sign that Gaztransport & Technigaz could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Gaztransport & Technigaz has more cash than debt is arguably a good indication that it can manage its debt safely.
But the bad news is that Gaztransport & Technigaz has seen its EBIT plunge 17% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Gaztransport & Technigaz 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. Gaztransport & Technigaz 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. During the last three years, Gaztransport & Technigaz produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case Gaztransport & Technigaz has €161.6m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of €147m, being 79% of its EBIT. So we are not troubled with Gaztransport & Technigaz's debt use. 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. For example - Gaztransport & Technigaz has 1 warning sign we think 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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