Gaming Innovation Group (OB:GIG) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Gaming Innovation Group Inc. (OB:GIG) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Gaming Innovation Group

How Much Debt Does Gaming Innovation Group Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Gaming Innovation Group had debt of €66.5m, up from €42.7m in one year. On the flip side, it has €14.1m in cash leading to net debt of about €52.4m.

How Healthy Is Gaming Innovation Group's Balance Sheet?

We can see from the most recent balance sheet that Gaming Innovation Group had liabilities of €39.8m falling due within a year, and liabilities of €78.7m due beyond that. Offsetting these obligations, it had cash of €14.1m as well as receivables valued at €21.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €82.5m.

While this might seem like a lot, it is not so bad since Gaming Innovation Group has a market capitalization of €319.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While we wouldn't worry about Gaming Innovation Group's net debt to EBITDA ratio of 3.4, we think its super-low interest cover of 1.4 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Looking on the bright side, Gaming Innovation Group boosted its EBIT by a silky 44% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Gaming Innovation Group can strengthen its balance sheet over time. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, Gaming Innovation Group generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Gaming Innovation Group's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But we must concede we find its interest cover has the opposite effect. All these things considered, it appears that Gaming Innovation Group can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Gaming Innovation Group (1 is significant) you should be aware of.

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.