Stock Analysis
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Nadex Co., Ltd. (TSE:7435) does use debt in its business. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Nadex
What Is Nadex's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of April 2024 Nadex had JP¥1.41b of debt, an increase on JP¥699.0m, over one year. But on the other hand it also has JP¥4.48b in cash, leading to a JP¥3.08b net cash position.
A Look At Nadex's Liabilities
According to the last reported balance sheet, Nadex had liabilities of JP¥10.5b due within 12 months, and liabilities of JP¥1.25b due beyond 12 months. Offsetting these obligations, it had cash of JP¥4.48b as well as receivables valued at JP¥11.4b due within 12 months. So it actually has JP¥4.10b more liquid assets than total liabilities.
This surplus strongly suggests that Nadex has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Nadex boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Nadex's saving grace is its low debt levels, because its EBIT has tanked 50% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Nadex'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. In the last three years, Nadex created free cash flow amounting to 15% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Nadex has net cash of JP¥3.08b, as well as more liquid assets than liabilities. So we don't have any problem with Nadex's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Nadex you should know about.
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. 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.
About TSE:7435
Nadex
Engages in the development, manufacture, sale, and installation of welding equipment in Japan, North America, China, Southeast Asia, and internationally.