Large-cap companies such as The Gap Inc (NYSE:GPS), with a market-capitalization of $13.35B, are much sought after by risk-averse investors who find diversified revenue streams and strong capital returns more comforting than explosive growth potential. But another key factor to consider when investing in GPS is its financial health. The significance of doing due diligence on a company’s financial strength stems from the fact that over 20,000 companies go bankrupt in every quarter in the US alone. Thus, it becomes utmost important for an investor to test a company’s resilience for such contingencies. In simple terms, I believe these three small calculations tell most of the story you need to know. View our latest analysis for Gap
Does GPS face the risk of succumbing to its debt-load?
What is considered a high debt-to-equity ratio differs depending on the industry, because some industries tend to utilize more debt financing than others. A ratio below 40% for large-cap stocks is considered as financially healthy, as a rule of thumb. In the case of GPS, the debt-to-equity ratio is 41.27%, which means, while the company’s debt could pose a problem for its earnings stability, it is not at an alarmingly high level yet. We can test if GPS’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings (EBIT) should cover interest by at least three times, therefore reducing concerns when profit is highly volatile. GPS’s profits amply covers interest at 23.53 times, which is seen as relatively safe. Debtors may be willing to loan the company more money, giving GPS ample headroom to grow its debt facilities.
Does GPS generate enough cash through operations?
A basic way to evaluate GPS’s debt management is to see whether the cash flow generated from the business is at a relatively high level compared to the debt capital invested. This also assesses GPS’s debt repayment capacity, which is not a big concern for a large company. GPS’s recent operating cash flow exceeded its debt obligations within the past year,which means GPS generates enough money in a year through its operations to pay off its near-term debt. Hence, debt poses a virtually insignificant risk for the company.This reflects proper cash and debt management by the company – great news for both debtholders and shareholders.
Next Steps:
Are you a shareholder? Although GPS’s debt level is towards the higher end of the spectrum, investors shouldn’t panic since its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. Given that GPS’s financial situation may differ over time, You should continue exploring market expectations for GPS’s future growth on our free analysis platform.