- Oops!Something went wrong.Please try again later.
Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Gulf Island Fabrication, Inc. ( NASDAQ:GIFI ) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Gulf Island Fabrication Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Gulf Island Fabrication had debt of US$9.46m, up from none in one year. However, its balance sheet shows it holds US$63.8m in cash, so it actually has US$54.3m net cash.
A Look At Gulf Island Fabrication's Liabilities
Zooming in on the latest balance sheet data, we can see that Gulf Island Fabrication had liabilities of US$112.4m due within 12 months and liabilities of US$8.51m due beyond that. Offsetting these obligations, it had cash of US$63.8m as well as receivables valued at US$96.8m due within 12 months. So it can boast US$39.6m more liquid assets than total liabilities.
This excess liquidity is a great indication that Gulf Island Fabrication's balance sheet is flexible. On this basis, we think its balance sheet is strong. Simply put, the fact that Gulf Island Fabrication has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Gulf Island Fabrication can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts .
Over 12 months, Gulf Island Fabrication made a loss at the EBIT level, and saw its revenue drop to US$273m, which is a fall of 4.0%. That's not what we would hope to see.
So How Risky Is Gulf Island Fabrication?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Gulf Island Fabrication lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$20m of cash and made a loss of US$46m. While this does make the company a bit risky, it's important to remember it has net cash of US$54.3m. That kitty means the company can keep spending for growth for at least two years, at current rates. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Gulf Island Fabrication you should be aware of, and 1 of them is a bit concerning.
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.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.