Is Nexteer Automotive Group (HKG:1316) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Nexteer Automotive Group Limited (HKG:1316) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that 1316 is potentially undervalued!

How Much Debt Does Nexteer Automotive Group Carry?

The image below, which you can click on for greater detail, shows that Nexteer Automotive Group had debt of US$106.8m at the end of June 2022, a reduction from US$114.3m over a year. But it also has US$317.4m in cash to offset that, meaning it has US$210.7m net cash.

How Strong Is Nexteer Automotive Group's Balance Sheet?

We can see from the most recent balance sheet that Nexteer Automotive Group had liabilities of US$961.0m falling due within a year, and liabilities of US$333.0m due beyond that. On the other hand, it had cash of US$317.4m and US$789.7m worth of receivables due within a year. So it has liabilities totalling US$186.8m more than its cash and near-term receivables, combined.

Since publicly traded Nexteer Automotive Group shares are worth a total of US$1.31b, it seems unlikely that this level of liabilities would be a major threat. 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, Nexteer Automotive Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Nexteer Automotive Group's load is not too heavy, because its EBIT was down 86% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Nexteer Automotive Group can strengthen its balance sheet over time. 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 Nexteer Automotive Group 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, Nexteer Automotive Group recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Nexteer Automotive Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$210.7m. So we don't have any problem with Nexteer Automotive Group's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Nexteer Automotive Group has 1 warning sign we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.