NagaCorp (HKG:3918) Has A Pretty Healthy Balance Sheet

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 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. We note that NagaCorp Ltd. (HKG:3918) 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for NagaCorp

What Is NagaCorp's Debt?

The image below, which you can click on for greater detail, shows that NagaCorp had debt of US$468.8m at the end of December 2022, a reduction from US$543.0m over a year. However, it does have US$178.9m in cash offsetting this, leading to net debt of about US$289.9m.

How Healthy Is NagaCorp's Balance Sheet?

The latest balance sheet data shows that NagaCorp had liabilities of US$198.7m due within a year, and liabilities of US$541.7m falling due after that. On the other hand, it had cash of US$178.9m and US$19.2m worth of receivables due within a year. So its liabilities total US$542.2m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because NagaCorp is worth US$2.33b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 1.2 and interest cover of 5.5 times, it seems to us that NagaCorp is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. We also note that NagaCorp improved its EBIT from a last year's loss to a positive US$127m. 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 NagaCorp'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, 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. Over the last year, NagaCorp actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, NagaCorp's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And we also thought its net debt to EBITDA was a positive. All these things considered, it appears that NagaCorp can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. We'd be motivated to research the stock further if we found out that NagaCorp insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.