Is Nextcom (TLV:NXTM) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Nextcom Ltd. (TLV:NXTM) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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, 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.

Check out our latest analysis for Nextcom

How Much Debt Does Nextcom Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Nextcom had debt of ₪71.1m, up from ₪62.5m in one year. On the flip side, it has ₪70.1m in cash leading to net debt of about ₪1.00m.

A Look At Nextcom's Liabilities

The latest balance sheet data shows that Nextcom had liabilities of ₪100.0m due within a year, and liabilities of ₪55.5m falling due after that. Offsetting these obligations, it had cash of ₪70.1m as well as receivables valued at ₪114.2m due within 12 months. So it actually has ₪28.7m more liquid assets than total liabilities.

This excess liquidity suggests that Nextcom is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Carrying virtually no net debt, Nextcom has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Nextcom has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.04 and EBIT of 10.9 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. Fortunately, Nextcom grew its EBIT by 6.0% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is Nextcom's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Nextcom's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Nextcom's impressive net debt to EBITDA implies it has the upper hand on its debt. And that's just the beginning of the good news since its interest cover is also very heartening. Zooming out, Nextcom seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. For instance, we've identified 3 warning signs for Nextcom that you should be aware of.

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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