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. Importantly, Gamma Communications plc (LON:GAMA) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Gamma Communications had UK£7.40m of debt, an increase on UK£1.80m, over one year. But it also has UK£142.9m in cash to offset that, meaning it has UK£135.5m net cash.

A Look At Gamma Communications' Liabilities

The latest balance sheet data shows that Gamma Communications had liabilities of UK£100.1m due within a year, and liabilities of UK£41.5m falling due after that. On the other hand, it had cash of UK£142.9m and UK£122.7m worth of receivables due within a year. So it can boast UK£124.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Gamma Communications could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Gamma Communications has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Gamma Communications has increased its EBIT by 5.6% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Gamma Communications has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Gamma Communications generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Gamma Communications has net cash of UK£135.5m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of UK£83m, being 90% of its EBIT. 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.