Is Gap (NYSE: GPS) Using Too Much Debt?

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Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried “. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies The Gap, Inc. (NYSE: GPS) uses debt. But does this debt concern shareholders?

What risk does debt entail?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. 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 Gap

What is Gap’s debt?

The graph below, which you can click for more details, shows that Gap had US $ 2.22 billion in debt as of July 2021; about the same as the year before. However, his balance sheet shows that he holds $ 2.71 billion in cash, so he actually has $ 492.0 million in net cash.

NYSE: GPS Historical Debt to Equity September 25, 2021

How healthy is Gap’s balance sheet?

The latest balance sheet data shows that Gap had liabilities of US $ 3.65 billion due within one year and liabilities of US $ 7.09 billion due thereafter. In compensation for these obligations, it had cash of US $ 2.71 billion as well as receivables valued at US $ 363.0 million due within 12 months. It therefore has liabilities totaling US $ 7.66 billion more than its cash and short-term receivables combined.

This deficit is sizable compared to its market cap of US $ 8.99 billion, so he suggests shareholders keep an eye on Gap’s use of debt. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly. While he has some liabilities to note, Gap also has more cash than debt, so we’re pretty confident he can handle his debt safely.

We also note that Gap improved its EBIT from a loss last year to a positive $ 854 million. When analyzing debt levels, the balance sheet is the obvious starting point. But it’s future profits, 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 analyst earnings forecast report interesting.

Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. While Gap has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building (or erodes) that cash balance. . Over the past year, Gap has generated strong free cash flow equivalent to 78% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.

In summary

Although Gap has more liabilities than liquid assets, it also has net cash of US $ 492.0 million. The icing on the cake is that he converted 78% of that EBIT into free cash flow, bringing in US $ 663 million. We are therefore not concerned with the use of debt by Gap. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 3 warning signs for Gap which you should know before investing here.

If you want to invest in businesses that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.

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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 does not have any position in the mentioned stocks.
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