These 4 Measures Indicate That New Hope (ASX:NHC) Is Using Debt Safely

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at 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$191.2m of debt at July 2022, down from AU$497.2m a year prior. But on the other hand it also has AU$815.7m in cash, leading to a AU$624.5m net cash position.

How Healthy Is New Hope's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that New Hope had liabilities of AU$537.2m due within 12 months and liabilities of AU$574.3m due beyond that. Offsetting these obligations, it had cash of AU$815.7m as well as receivables valued at AU$487.3m due within 12 months. So it can boast AU$191.5m 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 574% 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 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. New Hope 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. Over the last three years, New Hope recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that New Hope has net cash of AU$624.5m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of AU$1.1b, being 81% of its EBIT. So is New Hope's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for New Hope you should be aware of, and 1 of them makes us a bit uncomfortable.

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.