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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Gateley (Holdings) Plc (LON:GTLY) makes use of debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Gateley (Holdings) Carry?
The image below, which you can click on for greater detail, shows that Gateley (Holdings) had debt of UK£3.77m at the end of October 2020, a reduction from UK£4.55m over a year. But it also has UK£13.1m in cash to offset that, meaning it has UK£9.30m net cash.
A Look At Gateley (Holdings)'s Liabilities
The latest balance sheet data shows that Gateley (Holdings) had liabilities of UK£26.5m due within a year, and liabilities of UK£32.2m falling due after that. Offsetting these obligations, it had cash of UK£13.1m as well as receivables valued at UK£45.4m due within 12 months. So these liquid assets roughly match the total liabilities.
This state of affairs indicates that Gateley (Holdings)'s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the UK£209.1m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Gateley (Holdings) boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Gateley (Holdings) saw its EBIT drop by 8.7% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Gateley (Holdings)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Gateley (Holdings) 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, Gateley (Holdings) recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
We could understand if investors are concerned about Gateley (Holdings)'s liabilities, but we can be reassured by the fact it has has net cash of UK£9.30m. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in UK£18m. So we don't think Gateley (Holdings)'s use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Gateley (Holdings) 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.
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.
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