- Oops!Something went wrong.Please try again later.
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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Gentrack Group Limited (NZSE:GTK) does carry debt. But the more important question is: how much risk is that debt creating?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Gentrack Group Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 Gentrack Group had NZ$5.17m of debt, an increase on NZ$4.00m, over one year. However, it does have NZ$11.1m in cash offsetting this, leading to net cash of NZ$5.95m.
How Healthy Is Gentrack Group's Balance Sheet?
According to the last reported balance sheet, Gentrack Group had liabilities of NZ$30.1m due within 12 months, and liabilities of NZ$28.1m due beyond 12 months. Offsetting this, it had NZ$11.1m in cash and NZ$25.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NZ$22.0m.
Of course, Gentrack Group has a market capitalization of NZ$156.8m, 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. Despite its noteworthy liabilities, Gentrack Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Shareholders should be aware that Gentrack Group's EBIT was down 73% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 last three years, Gentrack Group recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While Gentrack Group does have more liabilities than liquid assets, it also has net cash of NZ$5.95m. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in NZ$16m. So we are not troubled with Gentrack Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Gentrack Group , and understanding them should be part of your investment process.
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.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email 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. 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. Thank you for reading.