Neochim AD (BUL:NEOH) Seems To Use Debt Rather Sparingly

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.' 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 Neochim AD (BUL:NEOH) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Neochim AD

What Is Neochim AD's Net Debt?

As you can see below, Neochim AD had лв3.40m of debt at September 2021, down from лв6.01m a year prior. However, its balance sheet shows it holds лв48.7m in cash, so it actually has лв45.3m net cash.

A Look At Neochim AD's Liabilities

According to the last reported balance sheet, Neochim AD had liabilities of лв24.4m due within 12 months, and liabilities of лв7.13m due beyond 12 months. Offsetting these obligations, it had cash of лв48.7m as well as receivables valued at лв2.06m due within 12 months. So it actually has лв19.2m more liquid assets than total liabilities.

This surplus liquidity suggests that Neochim AD's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Neochim AD boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Neochim AD has boosted its EBIT by 73%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Neochim AD's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Neochim AD 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. Happily for any shareholders, Neochim AD actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Neochim AD has net cash of лв45.3m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of лв31m, being 232% of its EBIT. When it comes to Neochim AD's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. For instance, we've identified 3 warning signs for Neochim AD (1 doesn't sit too well with us) you should be aware of.

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.

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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.