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. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Goldplat PLC (LON:GDP) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.
What Is Goldplat's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Goldplat had UK£839.0k of debt in December 2018, down from UK£1.37m, one year before. However, its balance sheet shows it holds UK£1.00m in cash, so it actually has UK£161.0k net cash.
How Strong Is Goldplat's Balance Sheet?
The latest balance sheet data shows that Goldplat had liabilities of UK£12.2m due within a year, and liabilities of UK£1.08m falling due after that. Offsetting these obligations, it had cash of UK£1.00m as well as receivables valued at UK£7.05m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£5.21m.
This is a mountain of leverage relative to its market capitalization of UK£6.36m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Goldplat also has more cash than debt, so we're pretty confident it can manage its debt safely.
Shareholders should be aware that Goldplat's EBIT was down 92% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Goldplat 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Goldplat 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, Goldplat created free cash flow amounting to 6.2% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Although Goldplat's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£161.0k. Despite the cash, we do find Goldplat's EBIT growth rate concerning, so we're not particularly comfortable with the stock. While Goldplat didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
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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