David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Gale Pacific Limited (ASX:GAP) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.
What Is Gale Pacific's Net Debt?
The image below, which you can click on for greater detail, shows that Gale Pacific had debt of AU$28.9m at the end of June 2021, a reduction from AU$43.1m over a year. However, its balance sheet shows it holds AU$30.4m in cash, so it actually has AU$1.47m net cash.
How Healthy Is Gale Pacific's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Gale Pacific had liabilities of AU$60.5m due within 12 months and liabilities of AU$35.0m due beyond that. Offsetting these obligations, it had cash of AU$30.4m as well as receivables valued at AU$41.5m due within 12 months. So its liabilities total AU$23.6m more than the combination of its cash and short-term receivables.
Gale Pacific has a market capitalization of AU$111.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Gale Pacific boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, Gale Pacific grew its EBIT by 174% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Gale Pacific's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Gale Pacific 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. During the last three years, Gale Pacific generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Although Gale Pacific's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$1.47m. And it impressed us with free cash flow of AU$31m, being 95% of its EBIT. So is Gale Pacific's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Gale Pacific you should know about.
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. 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.
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