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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 GCP Applied Technologies Inc. (NYSE:GCP) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
What Is GCP Applied Technologies's Net Debt?
The chart below, which you can click on for greater detail, shows that GCP Applied Technologies had US$348.6m in debt in June 2021; about the same as the year before. But it also has US$488.9m in cash to offset that, meaning it has US$140.3m net cash.
A Look At GCP Applied Technologies' Liabilities
According to the last reported balance sheet, GCP Applied Technologies had liabilities of US$233.7m due within 12 months, and liabilities of US$535.8m due beyond 12 months. Offsetting this, it had US$488.9m in cash and US$197.1m in receivables that were due within 12 months. So its liabilities total US$83.5m more than the combination of its cash and short-term receivables.
Of course, GCP Applied Technologies has a market capitalization of US$1.67b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, GCP Applied Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!
We note that GCP Applied Technologies grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. 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 GCP Applied Technologies'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. GCP Applied Technologies may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, GCP Applied Technologies's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
We could understand if investors are concerned about GCP Applied Technologies's liabilities, but we can be reassured by the fact it has has net cash of US$140.3m. And it impressed us with its EBIT growth of 24% over the last year. So we don't have any problem with GCP Applied Technologies's use of debt. 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. For example - GCP Applied Technologies has 2 warning signs we think you should be aware of.
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.
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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