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 note that Great Canadian Gaming Corporation (TSE:GC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Great Canadian Gaming's Debt?
As you can see below, Great Canadian Gaming had CA$603.9m of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. However, because it has a cash reserve of CA$304.0m, its net debt is less, at about CA$299.9m.
A Look At Great Canadian Gaming's Liabilities
The latest balance sheet data shows that Great Canadian Gaming had liabilities of CA$280.5m due within a year, and liabilities of CA$1.63b falling due after that. On the other hand, it had cash of CA$304.0m and CA$79.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$1.53b.
Great Canadian Gaming has a market capitalization of CA$2.57b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While Great Canadian Gaming's low debt to EBITDA ratio of 0.64 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.2 last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. It is well worth noting that Great Canadian Gaming's EBIT shot up like bamboo after rain, gaining 97% in the last twelve months. That'll make it easier to manage its debt. 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 Great Canadian Gaming'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Great Canadian Gaming recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Great Canadian Gaming's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Great Canadian Gaming can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. We'd be motivated to research the stock further if we found out that Great Canadian Gaming insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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