Is Gestamp Automoción (BME:GEST) a risky investment?

Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Gestamp Automocion, SA (BME: GEST) uses debt in its business. But the more important question is: what risk does this debt create?

Why is debt risky?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest review for Gestamp Automoción

What is Gestamp Automoción’s net debt?

The graph below, which you can click on for more details, shows that Gestamp Automoción had a debt of 3.41 billion euros in June 2022; about the same as the previous year. However, he has €1.53 billion in cash to offset this, resulting in a net debt of around €1.87 billion.

BME: GEST Debt to Equity History August 14, 2022

How healthy is Gestamp Automoción’s balance sheet?

According to the last published balance sheet, Gestamp Automoción had liabilities of €3.79 billion maturing within 12 months and liabilities of €3.30 billion maturing beyond 12 months. In return for these bonds, it had cash of €1.53 billion as well as receivables worth €1.71 billion at less than 12 months. Its liabilities therefore total 3.85 billion euros more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the company itself of 2.27 billion euros, like a child struggling under the weight of a huge backpack full of books, his sports equipment and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Gestamp Automoción would probably need a major recapitalization if it had to pay its creditors today.

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

Given its net debt to EBITDA of 1.5 and its interest coverage of 3.3 times, it seems to us that Gestamp Automoción is probably using debt quite sensibly. We therefore recommend that you closely monitor the impact of financing costs on the business. Unfortunately, Gestamp Automoción’s EBIT actually fell by 2.0% last year. If this earnings trend continues, its leverage will become heavy like the heart of a polar bear looking at its only cub. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Gestamp Automoción can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a company can only repay its debts with cold hard cash, not with book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Gestamp Automoción has recorded free cash flow representing 84% of its EBIT, which is higher than what we would normally expect. This positions him well to pay off debt if desired.

Our point of view

Reflecting on Gestamp Automoción’s attempt to stay on top of its total liabilities, we’re certainly not enthusiastic. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Looking at the balance sheet and taking all these factors into account, we believe that the debt makes the Gestamp Automoción stock a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Example: we have identified 3 warning signs for Gestamp Automoción you should be aware.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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