These 4 Measures Indicate That Nadex (TYO:7435) Is Using Debt Reasonably Well

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 can see that Nadex Co., Ltd. (TYO:7435) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Nadex

What Is Nadex's Debt?

As you can see below, at the end of October 2020, Nadex had JP¥2.55b of debt, up from JP¥201.0m a year ago. Click the image for more detail. But on the other hand it also has JP¥6.39b in cash, leading to a JP¥3.85b net cash position.

How Healthy Is Nadex's Balance Sheet?

We can see from the most recent balance sheet that Nadex had liabilities of JP¥12.7b falling due within a year, and liabilities of JP¥1.65b due beyond that. Offsetting this, it had JP¥6.39b in cash and JP¥9.43b in receivables that were due within 12 months. So it actually has JP¥1.45b more liquid assets than total liabilities.

It's good to see that Nadex has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Nadex has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Nadex's saving grace is its low debt levels, because its EBIT has tanked 42% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Nadex will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Nadex may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. 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¥3.85b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 112% of that EBIT to free cash flow, bringing in JP¥2.5b. So is Nadex's debt a risk? It doesn't seem so to us. 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. Be aware that Nadex is showing 4 warning signs in our investment analysis , and 1 of those can't be ignored...

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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This article by Simply Wall St is general in nature. 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.
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