Health Check: How Prudently Does GSTechnologies (LON:GST) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, GSTechnologies Ltd. (LON:GST) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for GSTechnologies

What Is GSTechnologies's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 GSTechnologies had US$1.73m of debt, an increase on none, over one year. However, it does have US$1.79m in cash offsetting this, leading to net cash of US$64.0k.

How Strong Is GSTechnologies' Balance Sheet?

We can see from the most recent balance sheet that GSTechnologies had liabilities of US$748.0k falling due within a year, and liabilities of US$1.84m due beyond that. Offsetting this, it had US$1.79m in cash and US$1.48m in receivables that were due within 12 months. So it actually has US$679.0k more liquid assets than total liabilities.

This surplus suggests that GSTechnologies has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that GSTechnologies has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since GSTechnologies 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 GSTechnologies had a loss before interest and tax, and actually shrunk its revenue by 57%, to US$3.0m. That makes us nervous, to say the least.

So How Risky Is GSTechnologies?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months GSTechnologies lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$263k of cash and made a loss of US$182k. Given it only has net cash of US$64.0k, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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 GSTechnologies has 4 warning signs (and 2 which are significant) we think you should know about.

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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