David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly,
The Gap, Inc. (NYSE:GPS) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.
What Is Gap's Debt?
You can click the graphic below for the historical numbers, but it shows that as of May 2021 Gap had US$2.22b of debt, an increase on US$1.75b, over one year. But on the other hand it also has US$2.54b in cash, leading to a US$323.0m net cash position.NYSE:GPS Debt to Equity History June 10th 2021
How Strong Is Gap's Balance Sheet?
The latest balance sheet data shows that Gap had liabilities of US$3.64b due within a year, and liabilities of US$7.16b falling due after that. On the other hand, it had cash of US$2.54b and US$363.0m worth of receivables due within a year. So its liabilities total US$7.89b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its very significant market capitalization of US$11.9b, so it does suggest shareholders should keep an eye on Gap's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Gap also has more cash than debt, so we're pretty confident it can manage its debt safely.
Pleasingly, Gap is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 144% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Gap'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 report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Gap may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Gap produced sturdy free cash flow equating to 62% 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.
While Gap does have more liabilities than liquid assets, it also has net cash of US$323.0m. And we liked the look of last year's 144% year-on-year EBIT growth. So we don't have any problem with Gap's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified > 3 warning signs for Gap (1 is a bit unpleasant)
> 3 warning signs for Gap (1 is a bit unpleasant)you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
This article by Simply Wall St is general in nature. 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.
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Source : https://www.nasdaq.com/articles/does-gap-nyse:gps-have-a-healthy-balance-sheet-2021-06-10919