Is GSTechnologies (LON:GST) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies GSTechnologies Ltd. (LON:GST) 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. If things get really bad, the lenders can take control of the business. 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. 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. 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 March 2021 GSTechnologies had US$1.66m of debt, an increase on none, over one year. But it also has US$1.74m in cash to offset that, meaning it has US$87.0k net cash.

How Healthy Is GSTechnologies' Balance Sheet?

According to the last reported balance sheet, GSTechnologies had liabilities of US$1.58m due within 12 months, and liabilities of US$1.21m due beyond 12 months. On the other hand, it had cash of US$1.74m and US$2.27m worth of receivables due within a year. So it can boast US$1.23m 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since GSTechnologies will need earnings to service that debt. 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.

In the last year GSTechnologies had a loss before interest and tax, and actually shrunk its revenue by 25%, to US$3.4m. To be frank that doesn't bode well.

So How Risky Is GSTechnologies?

By their very nature companies that are losing money are more risky than those with a long history of profitability. 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$1.1m of cash and made a loss of US$490k. Given it only has net cash of US$87.0k, 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. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for GSTechnologies (of which 1 shouldn't be ignored!) you should know about.

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.
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