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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Gigas Hosting, S.A. (BME:GIGA) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Gigas Hosting
What Is Gigas Hosting's Debt?
As you can see below, at the end of December 2018, Gigas Hosting had €4.35m of debt, up from €3.28m a year ago. Click the image for more detail. However, it does have €2.19m in cash offsetting this, leading to net debt of about €2.16m.
A Look At Gigas Hosting's Liabilities
The latest balance sheet data shows that Gigas Hosting had liabilities of €3.91m due within a year, and liabilities of €4.50m falling due after that. On the other hand, it had cash of €2.19m and €1.53m worth of receivables due within a year. So its liabilities total €4.69m more than the combination of its cash and short-term receivables.
Of course, Gigas Hosting has a market capitalization of €30.6m, so these liabilities are probably manageable. 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.
Even though Gigas Hosting's debt is only 1.7, its interest cover is really very low at 0.82. In large part that's it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there's no doubt the stock is using meaningful leverage. We also note that Gigas Hosting improved its EBIT from a last year's loss to a positive €92k. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Gigas Hosting can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.