We Think Nicolás Correa (BME:NEA) Can Stay On Top Of Its 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. We can see that Nicolás Correa, S.A. (BME:NEA) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Nicolás Correa

What Is Nicolás Correa's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Nicolás Correa had debt of €15.6m, up from €8.09m in one year. But it also has €17.6m in cash to offset that, meaning it has €1.94m net cash.

How Healthy Is Nicolás Correa's Balance Sheet?

The latest balance sheet data shows that Nicolás Correa had liabilities of €26.0m due within a year, and liabilities of €14.1m falling due after that. Offsetting these obligations, it had cash of €17.6m as well as receivables valued at €20.7m due within 12 months. So it has liabilities totalling €1.81m more than its cash and near-term receivables, combined.

Since publicly traded Nicolás Correa shares are worth a total of €57.7m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Nicolás Correa also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Nicolás Correa's load is not too heavy, because its EBIT was down 21% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Nicolás Correa'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. While Nicolás Correa has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Nicolás Correa recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

We could understand if investors are concerned about Nicolás Correa's liabilities, but we can be reassured by the fact it has has net cash of €1.94m. So we don't have any problem with Nicolás Correa's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Nicolás Correa 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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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. 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.
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