Is NCC Group (LON:NCC) Using Too Much 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.' 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. We can see that NCC Group plc (LON:NCC) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

See our latest analysis for NCC Group

How Much Debt Does NCC Group Carry?

The image below, which you can click on for greater detail, shows that at November 2020 NCC Group had debt of UK£98.1m, up from UK£54.6m in one year. But it also has UK£101.1m in cash to offset that, meaning it has UK£3.00m net cash.

How Healthy Is NCC Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NCC Group had liabilities of UK£92.5m due within 12 months and liabilities of UK£137.5m due beyond that. Offsetting these obligations, it had cash of UK£101.1m as well as receivables valued at UK£75.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£53.3m.

Given NCC Group has a market capitalization of UK£750.8m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, NCC Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, NCC Group saw its EBIT drop by 5.7% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 NCC Group's ability to maintain a healthy balance sheet going forward. 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. NCC Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, NCC Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that NCC Group has UK£3.00m in net cash. And it impressed us with free cash flow of UK£37m, being 137% of its EBIT. So we don't have any problem with NCC Group's use of debt. 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. For instance, we've identified 2 warning signs for NCC Group that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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