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 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 Gentrack Group Limited (NZSE:GTK) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Gentrack Group's Debt?
As you can see below, Gentrack Group had NZ$4.00m of debt at March 2019, down from NZ$44.7m a year prior. However, its balance sheet shows it holds NZ$6.40m in cash, so it actually has NZ$2.40m net cash.
A Look At Gentrack Group's Liabilities
We can see from the most recent balance sheet that Gentrack Group had liabilities of NZ$31.5m falling due within a year, and liabilities of NZ$16.2m due beyond that. Offsetting this, it had NZ$6.40m in cash and NZ$32.1m in receivables that were due within 12 months. So its liabilities total NZ$9.11m more than the combination of its cash and short-term receivables.
Having regard to Gentrack Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NZ$503.1m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Gentrack Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
In fact Gentrack Group's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Gentrack Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Gentrack Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Gentrack Group recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
We could understand if investors are concerned about Gentrack Group's liabilities, but we can be reassured by the fact it has has net cash of NZ$2.40m. So we don't have any problem with Gentrack Group's use of debt. Even though Gentrack Group lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.
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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