Is Nuheara (ASX:NUH) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Nuheara Limited (ASX:NUH) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Nuheara

What Is Nuheara's Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Nuheara had debt of AU$2.51m, up from none in one year. However, its balance sheet shows it holds AU$4.43m in cash, so it actually has AU$1.92m net cash.

How Healthy Is Nuheara's Balance Sheet?

The latest balance sheet data shows that Nuheara had liabilities of AU$5.54m due within a year, and liabilities of AU$2.56m falling due after that. On the other hand, it had cash of AU$4.43m and AU$1.57m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.10m.

Of course, Nuheara has a market capitalization of AU$65.8m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Nuheara boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nuheara 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.

Over 12 months, Nuheara made a loss at the EBIT level, and saw its revenue drop to AU$1.7m, which is a fall of 22%. That makes us nervous, to say the least.

So How Risky Is Nuheara?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Nuheara had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through AU$9.0m of cash and made a loss of AU$12m. Given it only has net cash of AU$1.92m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Nuheara you should be aware of, and 1 of them doesn't sit too well with us.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

When trading Nuheara or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.