These 4 Measures Indicate That Netcompany Group (CPH:NETC) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Netcompany Group A/S (CPH:NETC) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Netcompany Group

What Is Netcompany Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Netcompany Group had kr.1.74b of debt in September 2023, down from kr.2.02b, one year before. On the flip side, it has kr.100.5m in cash leading to net debt of about kr.1.64b.

A Look At Netcompany Group's Liabilities

According to the last reported balance sheet, Netcompany Group had liabilities of kr.1.67b due within 12 months, and liabilities of kr.2.45b due beyond 12 months. Offsetting these obligations, it had cash of kr.100.5m as well as receivables valued at kr.2.72b due within 12 months. So its liabilities total kr.1.31b more than the combination of its cash and short-term receivables.

Given Netcompany Group has a market capitalization of kr.11.6b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a debt to EBITDA ratio of 1.9, Netcompany Group uses debt artfully but responsibly. And the alluring interest cover (EBIT of 7.2 times interest expense) certainly does not do anything to dispel this impression. Sadly, Netcompany Group's EBIT actually dropped 7.5% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Netcompany Group's ability to maintain a healthy balance sheet going forward. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Netcompany Group recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Both Netcompany Group's ability to to convert EBIT to free cash flow and its interest cover gave us comfort that it can handle its debt. Having said that, its EBIT growth rate somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that Netcompany Group is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. To that end, you should be aware of the 1 warning sign we've spotted with Netcompany Group .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.