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 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 can see that Gusbourne PLC (LON:GUS) does use debt in its business. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Gusbourne Carry?
The chart below, which you can click on for greater detail, shows that Gusbourne had UK£5.71m in debt in June 2019; about the same as the year before. On the flip side, it has UK£481.0k in cash leading to net debt of about UK£5.23m.
A Look At Gusbourne’s Liabilities
According to the last reported balance sheet, Gusbourne had liabilities of UK£2.00m due within 12 months, and liabilities of UK£6.35m due beyond 12 months. On the other hand, it had cash of UK£481.0k and UK£731.0k worth of receivables due within a year. So it has liabilities totalling UK£7.14m more than its cash and near-term receivables, combined.
Gusbourne has a market capitalization of UK£30.8m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Gusbourne will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Gusbourne wasn’t profitable at an EBIT level, but managed to grow its revenue by48%, to UK£1.5m. With any luck the company will be able to grow its way to profitability.
Despite the top line growth, Gusbourne still had negative earnings before interest and tax (EBIT), over the last year. To be specific the EBIT loss came in at UK£1.7m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn’t help that it burned through UK£3.3m of cash over the last year. So suffice it to say we consider the stock very risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we’re providing readers this interactive graph showing how Gusbourne’s profit, revenue, and operating cashflow have changed over the last few years.
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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