Is Global Fashion Group (ETR:GFG) Using Debt In A Risky Way?

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.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We can see that Global Fashion Group S.A. (ETR:GFG) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Our analysis indicates that GFG is potentially overvalued!

What Is Global Fashion Group’s Net Debt?

As you can see below, Global Fashion Group had €268.4m of debt at June 2022, down from €338.3m a year prior. However, its balance sheet shows it holds €488.7m in cash, so it actually has €220.3m net cash.

A Look At Global Fashion Group’s Liabilities

The latest balance sheet data shows that Global Fashion Group had liabilities of €594.7m due within a year, and liabilities of €419.1m falling due after that. Offsetting these obligations, it had cash of €488.7m as well as receivables valued at €50.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €474.6m.

The deficiency here weighs heavily on the €294.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. After all, Global Fashion Group would likely require a major re-capitalisation if it had to pay its creditors today. Global Fashion Group boasts net cash, so it’s fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. 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 Global Fashion Group’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.

Over 12 months, Global Fashion Group reported revenue of €1.7b, which is a gain of 18%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Global Fashion Group?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Global Fashion Group had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of €98m and booked a €110m accounting loss. But at least it has €220.3m on the balance sheet to spend on growth, near-term. Overall, we’d say the stock is a bit risky, and we’re usually very cautious until we see positive free cash flow. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. These risks can be hard to spot. Every company has them, and we’ve spotted 2 warning signs for Global Fashion Group (of which 1 doesn’t sit too well with us!) you should know about.

At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.