Stock Analysis

These 4 Measures Indicate That NAHL Group (LON:NAH) Is Using Debt Reasonably Well

AIM:NAH
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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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies NAHL Group plc (LON:NAH) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

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How Much Debt Does NAHL Group Carry?

As you can see below, NAHL Group had UK£18.0m of debt at June 2021, down from UK£21.9m a year prior. However, it does have UK£3.04m in cash offsetting this, leading to net debt of about UK£14.9m.

debt-equity-history-analysis
AIM:NAH Debt to Equity History November 21st 2021

How Strong Is NAHL Group's Balance Sheet?

According to the last reported balance sheet, NAHL Group had liabilities of UK£23.2m due within 12 months, and liabilities of UK£20.8m due beyond 12 months. Offsetting these obligations, it had cash of UK£3.04m as well as receivables valued at UK£34.1m due within 12 months. So it has liabilities totalling UK£6.87m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since NAHL Group has a market capitalization of UK£24.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

NAHL Group has net debt to EBITDA of 2.7 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 7.6 suggests it can easily service that debt. We also note that NAHL Group improved its EBIT from a last year's loss to a positive UK£4.4m. There's no doubt that we learn most about debt from the balance sheet. But it is NAHL Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, NAHL Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

NAHL Group's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that NAHL Group can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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 NAHL Group you should be aware of, and 1 of them can't be ignored.

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. 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.

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