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. We note that GCP Applied Technologies Inc. (NYSE:GCP) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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.
What Is GCP Applied Technologies's Net Debt?
As you can see below, GCP Applied Technologies had US$348.6m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$488.9m in cash, so it actually has US$140.3m net cash.
How Strong Is GCP Applied Technologies' Balance Sheet?
We can see from the most recent balance sheet that GCP Applied Technologies had liabilities of US$233.7m falling due within a year, and liabilities of US$535.8m due beyond that. On the other hand, it had cash of US$488.9m and US$197.1m worth of receivables due within a year. So it has liabilities totalling US$83.5m more than its cash and near-term receivables, combined.
Of course, GCP Applied Technologies has a market capitalization of US$1.72b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, GCP Applied Technologies also has more cash than debt, so we're pretty confident it can manage its debt safely.
We note that GCP Applied Technologies grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. 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 GCP Applied Technologies'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. GCP Applied Technologies 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. In the last three years, GCP Applied Technologies's free cash flow amounted to 34% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
We could understand if investors are concerned about GCP Applied Technologies's liabilities, but we can be reassured by the fact it has has net cash of US$140.3m. And it impressed us with its EBIT growth of 24% over the last year. So we are not troubled with GCP Applied Technologies's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with GCP Applied Technologies , and understanding them should be part of your investment process.
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.
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