Is Neo Performance Materials (TSE:NEO) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Neo Performance Materials Inc. (TSE:NEO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, 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.

Check out our latest analysis for Neo Performance Materials

What Is Neo Performance Materials's Net Debt?

As you can see below, at the end of September 2022, Neo Performance Materials had US$21.7m of debt, up from US$5.49m a year ago. Click the image for more detail. But it also has US$123.9m in cash to offset that, meaning it has US$102.2m net cash.

A Look At Neo Performance Materials' Liabilities

Zooming in on the latest balance sheet data, we can see that Neo Performance Materials had liabilities of US$107.1m due within 12 months and liabilities of US$48.5m due beyond that. On the other hand, it had cash of US$123.9m and US$81.7m worth of receivables due within a year. So it actually has US$50.0m more liquid assets than total liabilities.

This excess liquidity suggests that Neo Performance Materials is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Neo Performance Materials has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Neo Performance Materials has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Neo Performance Materials can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Neo Performance Materials 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, Neo Performance Materials recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Neo Performance Materials has US$102.2m in net cash and a decent-looking balance sheet. And we liked the look of last year's 29% year-on-year EBIT growth. So we don't think Neo Performance Materials's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Neo Performance Materials (of which 1 is concerning!) you should know about.

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.