Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies GR Engineering Services Limited (ASX:GNG) 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does GR Engineering Services Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2021 GR Engineering Services had AU$7.03m of debt, an increase on AU$6.67m, over one year. However, it does have AU$93.6m in cash offsetting this, leading to net cash of AU$86.5m.
How Healthy Is GR Engineering Services' Balance Sheet?
According to the last reported balance sheet, GR Engineering Services had liabilities of AU$180.8m due within 12 months, and liabilities of AU$4.64m due beyond 12 months. Offsetting this, it had AU$93.6m in cash and AU$108.1m in receivables that were due within 12 months. So it actually has AU$16.2m more liquid assets than total liabilities.
This surplus suggests that GR Engineering Services has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, GR Engineering Services boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that GR Engineering Services grew its EBIT by 137% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since GR Engineering Services will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While GR Engineering Services 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. Happily for any shareholders, GR Engineering Services actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While we empathize with investors who find debt concerning, you should keep in mind that GR Engineering Services has net cash of AU$86.5m, as well as more liquid assets than liabilities. The cherry on top was that in converted 172% of that EBIT to free cash flow, bringing in AU$69m. So is GR Engineering Services's debt a risk? It doesn't seem so to us. 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 1 warning sign for GR Engineering Services that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.