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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that GTN Limited (ASX:GTN) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for GTN
How Much Debt Does GTN Carry?
As you can see below, GTN had AU$58.6m of debt at December 2018, down from AU$97.9m a year prior. However, because it has a cash reserve of AU$38.6m, its net debt is less, at about AU$20.0m.
How Strong Is GTN's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that GTN had liabilities of AU$30.5m due within 12 months and liabilities of AU$79.3m due beyond that. Offsetting these obligations, it had cash of AU$38.6m as well as receivables valued at AU$40.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$30.6m.
Given GTN has a market capitalization of AU$202.7m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
GTN has a low debt to EBITDA ratio of only 0.53. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. On the other hand, GTN's EBIT dived 15%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if GTN 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.