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 can see that GTT Communications, Inc. (NYSE:GTT) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does GTT Communications Carry?
As you can see below, GTT Communications had US$3.25b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. And it doesn't have much cash, so its net debt is about the same.
How Healthy Is GTT Communications's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that GTT Communications had liabilities of US$549.0m due within 12 months and liabilities of US$3.99b due beyond that. On the other hand, it had cash of US$33.8m and US$241.7m worth of receivables due within a year. So it has liabilities totalling US$4.26b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$552.9m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, GTT Communications would probably need a major re-capitalization if its creditors were to demand repayment.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 0.73 times and a disturbingly high net debt to EBITDA ratio of 7.6 hit our confidence in GTT Communications like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, it should be some comfort for shareholders to recall that GTT Communications actually grew its EBIT by a hefty 155%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. 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 GTT Communications'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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, GTT Communications barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.
To be frank both GTT Communications's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider GTT Communications to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. Given our concerns about GTT Communications's debt levels, it seems only prudent to check if insiders have been ditching the stock.
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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