Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 note that Nexi S.p.A. (BIT:NEXI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Nexi
What Is Nexi's Debt?
As you can see below, at the end of June 2020, Nexi had €3.78b of debt, up from €3.17b a year ago. Click the image for more detail. On the flip side, it has €577.2m in cash leading to net debt of about €3.21b.
A Look At Nexi's Liabilities
The latest balance sheet data shows that Nexi had liabilities of €448.4m due within a year, and liabilities of €4.05b falling due after that. Offsetting this, it had €577.2m in cash and €1.19b in receivables that were due within 12 months. So it has liabilities totalling €2.73b more than its cash and near-term receivables, combined.
Nexi has a very large market capitalization of €10.1b, so it could very likely raise cash to ameliorate 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 7.9 hit our confidence in Nexi like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, one redeeming factor is that Nexi grew its EBIT at 11% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Nexi 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Nexi's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
Both Nexi's interest cover and its net debt to EBITDA were discouraging. At least its EBIT growth rate gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Nexi is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Nexi .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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About BIT:NEXI
Nexi
Provides electronic money and payment services to banks, small and medium-sized enterprises, large international companies, institutions, and public administrations in Italy.
Excellent balance sheet and fair value.