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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.’ 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, NFON AG (FRA:NFN) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is NFON’s Net Debt?
As you can see below, at the end of March 2019, NFON had €10.5m of debt, up from €2.57m a year ago. Click the image for more detail. But it also has €31.5m in cash to offset that, meaning it has €21.0m net cash.
How Strong Is NFON’s Balance Sheet?
We can see from the most recent balance sheet that NFON had liabilities of €20.1m falling due within a year, and liabilities of €4.33m due beyond that. Offsetting this, it had €31.5m in cash and €6.75m in receivables that were due within 12 months. So it can boast €13.9m more liquid assets than total liabilities.
This surplus suggests that NFON has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Given that NFON has more cash than debt, we’re pretty confident it can manage its debt safely. 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 NFON 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.
Over 12 months, NFON reported revenue of €45m, which is a gain of 21%. With any luck the company will be able to grow its way to profitability.
So How Risky Is NFON?
We have no doubt that loss making companies are, in general, riskier than profitable ones. Anf the fact is that over the last twelve months NFON lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of €8.2m and booked a €9.4m accounting loss. While this does make the company a bit risky, it’s important to remember it has net cash of €32m. That kitty means the company can keep spending for growth for at least three years, at current rates. NFON’s revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards. For riskier companies like NFON I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.