Is Novatti Group (ASX:NOV) Using Debt In A Risky Way?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Novatti Group Limited (ASX:NOV) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Novatti Group

What Is Novatti Group's Debt?

As you can see below, at the end of June 2023, Novatti Group had AU$10.5m of debt, up from AU$40.0k a year ago. Click the image for more detail. However, it does have AU$18.2m in cash offsetting this, leading to net cash of AU$7.72m.

How Healthy Is Novatti Group's Balance Sheet?

The latest balance sheet data shows that Novatti Group had liabilities of AU$117.9m due within a year, and liabilities of AU$12.2m falling due after that. Offsetting this, it had AU$18.2m in cash and AU$7.75m in receivables that were due within 12 months. So it has liabilities totalling AU$104.2m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the AU$32.5m 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, Novatti Group would likely require a major re-capitalisation if it had to pay its creditors today. Given that Novatti Group has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Novatti Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Novatti Group wasn't profitable at an EBIT level, but managed to grow its revenue by 20%, to AU$39m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Novatti Group?

While Novatti Group lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow AU$1.0m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. 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 Novatti Group (of which 1 is a bit unpleasant!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.