Is G1 Secure Solutions (TLV:GOSS) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, G1 Secure Solutions Ltd (TLV:GOSS) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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. 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.

Check out our latest analysis for G1 Secure Solutions

What Is G1 Secure Solutions's Debt?

As you can see below, at the end of September 2020, G1 Secure Solutions had ₪51.2m of debt, up from ₪43.4m a year ago. Click the image for more detail. However, because it has a cash reserve of ₪11.1m, its net debt is less, at about ₪40.1m.

How Strong Is G1 Secure Solutions' Balance Sheet?

We can see from the most recent balance sheet that G1 Secure Solutions had liabilities of ₪262.0m falling due within a year, and liabilities of ₪59.3m due beyond that. Offsetting these obligations, it had cash of ₪11.1m as well as receivables valued at ₪231.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪78.5m.

Of course, G1 Secure Solutions has a market capitalization of ₪553.3m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

G1 Secure Solutions has a low net debt to EBITDA ratio of only 0.45. And its EBIT covers its interest expense a whopping 131 times over. So we're pretty relaxed about its super-conservative use of debt. While G1 Secure Solutions doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since G1 Secure Solutions 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, G1 Secure Solutions recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

G1 Secure Solutions's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, G1 Secure Solutions seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for G1 Secure Solutions you should be aware of.

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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This article by Simply Wall St is general in nature. 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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