Here's Why Nadex (TYO:7435) Can Manage Its Debt Responsibly

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.' 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 Nadex Co., Ltd. (TYO:7435) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Nadex

How Much Debt Does Nadex Carry?

As you can see below, Nadex had JP¥1.60b of debt at January 2021, down from JP¥4.44b a year prior. But it also has JP¥5.15b in cash to offset that, meaning it has JP¥3.55b net cash.

How Healthy Is Nadex's Balance Sheet?

The latest balance sheet data shows that Nadex had liabilities of JP¥9.07b due within a year, and liabilities of JP¥2.47b falling due after that. Offsetting these obligations, it had cash of JP¥5.15b as well as receivables valued at JP¥8.91b due within 12 months. So it actually has JP¥2.51b more liquid assets than total liabilities.

This excess liquidity is a great indication that Nadex's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Nadex has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Nadex if management cannot prevent a repeat of the 42% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nadex's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Nadex 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. Over the last three years, Nadex actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Nadex has JP¥3.55b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥2.5b, being 102% of its EBIT. So we don't think Nadex's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Nadex (1 is a bit unpleasant) 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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