Does New Hope (ASX:NHC) Have A Healthy Balance Sheet?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that New Hope Corporation Limited (ASX:NHC) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for New Hope

What Is New Hope's Net Debt?

As you can see below, New Hope had AU$188.8m of debt at January 2022, down from AU$377.3m a year prior. But it also has AU$513.1m in cash to offset that, meaning it has AU$324.3m net cash.

How Healthy Is New Hope's Balance Sheet?

The latest balance sheet data shows that New Hope had liabilities of AU$320.4m due within a year, and liabilities of AU$485.2m falling due after that. Offsetting these obligations, it had cash of AU$513.1m as well as receivables valued at AU$175.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$117.2m.

Since publicly traded New Hope shares are worth a total of AU$2.87b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, New Hope also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although New Hope made a loss at the EBIT level, last year, it was also good to see that it generated AU$721m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if New Hope can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While New Hope has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, New Hope recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that New Hope has AU$324.3m in net cash. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in AU$637m. So we don't think New Hope's use of debt is risky. 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. Be aware that New Hope is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.