Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies GT Steel Construction Group Limited (HKG:8402) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is GT Steel Construction Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 GT Steel Construction Group had S$3.57m of debt, an increase on S$3.43m, over one year. But on the other hand it also has S$6.99m in cash, leading to a S$3.42m net cash position.
How Healthy Is GT Steel Construction Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that GT Steel Construction Group had liabilities of S$9.82m due within 12 months and liabilities of S$1.40m due beyond that. On the other hand, it had cash of S$6.99m and S$25.5m worth of receivables due within a year. So it can boast S$21.3m more liquid assets than total liabilities.
This luscious liquidity implies that GT Steel Construction Group's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, GT Steel Construction Group boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that GT Steel Construction Group has seen its EBIT plunge 11% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 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. GT Steel Construction Group 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, GT Steel Construction Group created free cash flow amounting to 8.5% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
While it is always sensible to investigate a company's debt, in this case GT Steel Construction Group has S$3.42m in net cash and a decent-looking balance sheet. So we don't have any problem with GT Steel Construction Group's use of debt. 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. Be aware that GT Steel Construction Group is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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