Warren Buffett said: “Volatility is far from synonymous with risk”. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We note that CGI inc. (TSE: GIB.A) has debt on its balance sheet. But the most important question is: what risk does this debt create?
When Is Debt a Problem?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for CGI
What is CGI’s debt?
You can click on the chart below for historical numbers, but it shows CGI had C $ 3.42 billion in debt in June 2021, up from C $ 3.75 billion a year earlier. However, it has C $ 1.27 billion in cash offsetting this, which leads to net debt of around C $ 2.15 billion.
A look at CGI’s liabilities
The latest balance sheet data shows CGI had C $ 3.99 billion in liabilities due within one year and C $ 4.00 billion in liabilities due thereafter. In compensation for these obligations, it had cash of C $ 1.27 billion as well as receivables valued at C $ 2.23 billion maturing within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by C $ 4.49 billion.
Given that CGI has a colossal market capitalization of C $ 28.4 billion, it’s hard to believe that these liabilities pose a big threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
CGI has a low net debt to EBITDA ratio of just 1.0. And its EBIT easily covers its interest costs, being 19.5 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. The good news is that CGI increased its EBIT by 3.4% year-over-year, which should allay concerns about debt repayment. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine CGI’s ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, CGI has recorded free cash flow totaling 82% of its EBIT, which is higher than what we normally expected. This puts him in a very strong position to pay off the debt.
Our point of view
Fortunately, CGI’s impressive interest coverage means it has the upper hand over its debt. And this is only the beginning of good news as its conversion from EBIT to free cash flow is also very encouraging. Overall, we think CGI’s use of debt seems perfectly reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. 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 off the balance sheet. Note that CGI displays 1 warning sign in our investment analysis , you must know…
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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