Is GT Steel Construction Group (HKG:8402) Using Debt Sensibly?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that GT Steel Construction Group Limited (HKG:8402) 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 and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for GT Steel Construction Group

What Is GT Steel Construction Group's Net Debt?

As you can see below, at the end of December 2020, GT Steel Construction Group had S$5.94m of debt, up from S$3.60m a year ago. Click the image for more detail. But it also has S$7.87m in cash to offset that, meaning it has S$1.92m net cash.

How Healthy Is GT Steel Construction Group's Balance Sheet?

We can see from the most recent balance sheet that GT Steel Construction Group had liabilities of S$7.44m falling due within a year, and liabilities of S$6.09m due beyond that. Offsetting these obligations, it had cash of S$7.87m as well as receivables valued at S$22.0m due within 12 months. So it can boast S$16.3m more liquid assets than total liabilities.

This surplus suggests that GT Steel Construction Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that GT Steel Construction Group has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is GT Steel Construction Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year GT Steel Construction Group had a loss before interest and tax, and actually shrunk its revenue by 80%, to S$10m. That makes us nervous, to say the least.

So How Risky Is GT Steel Construction Group?

Although GT Steel Construction Group had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of S$4.3m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example GT Steel Construction Group has 3 warning signs (and 1 which can't be ignored) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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