New Hope (ASX:NHC) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that New Hope Corporation Limited (ASX:NHC) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for New Hope

How Much Debt Does New Hope Carry?

You can click the graphic below for the historical numbers, but it shows that New Hope had AU$68.5m of debt in January 2023, down from AU$188.8m, one year before. However, its balance sheet shows it holds AU$1.07b in cash, so it actually has AU$1.00b net cash.

A Look At New Hope's Liabilities

The latest balance sheet data shows that New Hope had liabilities of AU$592.3m due within a year, and liabilities of AU$276.8m falling due after that. Offsetting this, it had AU$1.07b in cash and AU$161.0m in receivables that were due within 12 months. So it actually has AU$363.2m more liquid assets than total liabilities.

This short term liquidity is a sign that New Hope could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, New Hope boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that New Hope grew its EBIT by 169% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine New Hope's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. During the last two years, New Hope generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case New Hope has AU$1.00b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in AU$1.5b. So is New Hope's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. 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 3 warning signs for New Hope (of which 1 is a bit unpleasant!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.