Netcall (LON:NET) Seems To Use Debt Rather Sparingly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Netcall plc (LON:NET) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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 Netcall

What Is Netcall's Net Debt?

As you can see below, Netcall had UK£6.80m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has UK£12.9m in cash, leading to a UK£6.10m net cash position.

How Strong Is Netcall's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Netcall had liabilities of UK£18.4m due within 12 months and liabilities of UK£8.42m due beyond that. Offsetting this, it had UK£12.9m in cash and UK£4.12m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£9.78m.

Of course, Netcall has a market capitalization of UK£95.9m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Netcall boasts net cash, so it's fair to say it does not have a heavy debt load!

Also relevant is that Netcall has grown its EBIT by a very respectable 27% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Netcall can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Netcall 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. Happily for any shareholders, Netcall actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although Netcall's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£6.10m. And it impressed us with free cash flow of UK£8.3m, being 248% of its EBIT. So is Netcall's debt a risk? It doesn't seem so to us. 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. Be aware that Netcall is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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. 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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