We Think Genuit Group (LON:GEN) Can Stay On Top Of Its Debt

Simply Wall St · 05/13 10:29

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. Importantly, Genuit Group plc (LON:GEN) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Genuit Group

How Much Debt Does Genuit Group Carry?

The image below, which you can click on for greater detail, shows that Genuit Group had debt of UK£142.9m at the end of December 2023, a reduction from UK£193.1m over a year. On the flip side, it has UK£17.0m in cash leading to net debt of about UK£125.9m.

LSE:GEN Debt to Equity History May 13th 2024

How Strong Is Genuit Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Genuit Group had liabilities of UK£130.8m due within 12 months and liabilities of UK£211.4m due beyond that. On the other hand, it had cash of UK£17.0m and UK£72.5m worth of receivables due within a year. So it has liabilities totalling UK£252.7m more than its cash and near-term receivables, combined.

Genuit Group has a market capitalization of UK£1.14b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Genuit Group's low debt to EBITDA ratio of 1.1 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.8 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Fortunately, Genuit Group grew its EBIT by 2.4% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Genuit Group's ability to maintain a healthy balance sheet going forward. 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. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Genuit Group produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

We feel that Genuit Group's solid net debt to EBITDA was really heart warming, like a mid-winter fair trade hot chocolate in a tasteful alpine chalet. And its conversion of EBIT to free cash flow should also leave shareholders feeling frolicsome. All these things considered, it appears that Genuit Group can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Genuit Group has 2 warning signs we think you should be aware of.

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.