Is NorCom Information Technology GmbH KGaA (ETR:NC5A) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, NorCom Information Technology GmbH & Co. KGaA (ETR:NC5A) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for NorCom Information Technology GmbH KGaA

What Is NorCom Information Technology GmbH KGaA's Net Debt?

As you can see below, NorCom Information Technology GmbH KGaA had €1.89m of debt at June 2020, down from €2.37m a year prior. But on the other hand it also has €4.71m in cash, leading to a €2.81m net cash position.

How Healthy Is NorCom Information Technology GmbH KGaA's Balance Sheet?

The latest balance sheet data shows that NorCom Information Technology GmbH KGaA had liabilities of €2.06m due within a year, and liabilities of €3.68m falling due after that. On the other hand, it had cash of €4.71m and €2.09m worth of receivables due within a year. So it can boast €1.06m more liquid assets than total liabilities.

This surplus suggests that NorCom Information Technology GmbH KGaA has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that NorCom Information Technology GmbH KGaA has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since NorCom Information Technology GmbH KGaA will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year NorCom Information Technology GmbH KGaA had a loss before interest and tax, and actually shrunk its revenue by 14%, to €11m. That's not what we would hope to see.

So How Risky Is NorCom Information Technology GmbH KGaA?

While NorCom Information Technology GmbH KGaA lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow €380k. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for NorCom Information Technology GmbH KGaA (1 makes us a bit uncomfortable) 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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