Is Gamma Communications (LON:GAMA) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Gamma Communications plc (LON:GAMA) does use debt in its business. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Gamma Communications

What Is Gamma Communications's Debt?

As you can see below, Gamma Communications had UK£3.00m of debt at June 2022, down from UK£5.20m a year prior. But it also has UK£75.6m in cash to offset that, meaning it has UK£72.6m net cash.

How Strong Is Gamma Communications' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gamma Communications had liabilities of UK£77.6m due within 12 months and liabilities of UK£31.9m due beyond that. Offsetting these obligations, it had cash of UK£75.6m as well as receivables valued at UK£114.3m due within 12 months. So it can boast UK£80.4m more liquid assets than total liabilities.

This surplus suggests that Gamma Communications has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Gamma Communications has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Gamma Communications saw its EBIT decline by 9.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Gamma Communications's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Gamma Communications 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. Over the most recent three years, Gamma Communications recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Gamma Communications has UK£72.6m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in UK£65m. So we don't think Gamma Communications's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Gamma Communications's earnings per share history for free.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.