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. We note that G. K. Goh Holdings Limited (SGX:G41) does have debt on its balance sheet . But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for G. K. Goh Holdings
What Is G. K. Goh Holdings's Debt?
The image below, which you can click on for greater detail, shows that G. K. Goh Holdings had debt of S$170.4m at the end of December 2021, a reduction from S$213.0m over a year. However, because it has a cash reserve of S$56.3m, its net debt is less, at about S$114.1m.SGX:G41 Debt to Equity History April 29th 2022
A Look At G. K. Goh Holdings' Liabilities
According to the last reported balance sheet, G. K. Goh Holdings had liabilities of S$228.8m due within 12 months, and liabilities of S$33.5m due beyond 12 months. On the other hand, it had cash of S$56.3m and S$1.03m worth of receivables due within a year. So its liabilities total S$204.9m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of S$303.4m, so it does suggest shareholders should keep an eye on G. K. Goh Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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.
Weak interest cover of 0.69 times and a disturbingly high net debt to EBITDA ratio of 13.4 hit our confidence in G. K. Goh Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that G. K. Goh Holdings achieved a positive EBIT of S$2.3m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But it is G. K. Goh Holdings'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, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, G. K. Goh Holdings burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
On the face of it, G. K. Goh Holdings's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. We're quite clear that we consider G. K. Goh Holdings to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that G. K. Goh Holdings is showing 2 warning signs in our investment analysis , and 1 of those is concerning...
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.