Is NNIT (CPH:NNIT) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that NNIT A/S (CPH:NNIT) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for NNIT

What Is NNIT's Net Debt?

As you can see below, at the end of December 2020, NNIT had kr.325.0m of debt, up from kr.259.0m a year ago. Click the image for more detail. However, because it has a cash reserve of kr.143.0m, its net debt is less, at about kr.182.0m.

How Healthy Is NNIT's Balance Sheet?

According to the last reported balance sheet, NNIT had liabilities of kr.867.0m due within 12 months, and liabilities of kr.661.0m due beyond 12 months. On the other hand, it had cash of kr.143.0m and kr.729.0m worth of receivables due within a year. So its liabilities total kr.656.0m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because NNIT is worth kr.2.59b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt sitting at just 0.46 times EBITDA, NNIT is arguably pretty conservatively geared. And it boasts interest cover of 8.3 times, which is more than adequate. The modesty of its debt load may become crucial for NNIT if management cannot prevent a repeat of the 31% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if NNIT 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, NNIT actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Based on what we've seen NNIT is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. We would also note that Healthcare Services industry companies like NNIT commonly do use debt without problems. Considering this range of data points, we think NNIT is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with NNIT .

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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