Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Nexteer Automotive Group Limited (HKG:1316) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Nexteer Automotive Group's Debt?
As you can see below, Nexteer Automotive Group had US$84.4m of debt at December 2021, down from US$248.6m a year prior. However, its balance sheet shows it holds US$326.5m in cash, so it actually has US$242.1m net cash.
A Look At Nexteer Automotive Group's Liabilities
According to the last reported balance sheet, Nexteer Automotive Group had liabilities of US$942.1m due within 12 months, and liabilities of US$261.8m due beyond 12 months. On the other hand, it had cash of US$326.5m and US$745.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$132.3m.
Since publicly traded Nexteer Automotive Group shares are worth a total of US$1.60b, 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, Nexteer Automotive Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
In fact Nexteer Automotive Group's saving grace is its low debt levels, because its EBIT has tanked 40% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Nexteer Automotive Group'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 company can only pay off debt with cold hard cash, not accounting profits. 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. In the last three years, Nexteer Automotive Group's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Nexteer Automotive Group has US$242.1m in net cash. So we don't have any problem with Nexteer Automotive Group'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. Be aware that Nexteer Automotive Group is showing 1 warning sign in our investment analysis , you should know about...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.