Is NIC Autotec (TYO:5742) A Risky Investment?

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.' 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. As with many other companies NIC Autotec, Inc. (TYO:5742) makes use of debt. But the more important question is: how much risk is that debt creating?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for NIC Autotec

What Is NIC Autotec's Debt?

The chart below, which you can click on for greater detail, shows that NIC Autotec had JP¥1.11b in debt in September 2020; about the same as the year before. However, it does have JP¥1.21b in cash offsetting this, leading to net cash of JP¥102.0m.

How Healthy Is NIC Autotec's Balance Sheet?

The latest balance sheet data shows that NIC Autotec had liabilities of JP¥1.73b due within a year, and liabilities of JP¥1.39b falling due after that. On the other hand, it had cash of JP¥1.21b and JP¥2.13b worth of receivables due within a year. So it actually has JP¥222.0m more liquid assets than total liabilities.

This surplus suggests that NIC Autotec has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that NIC Autotec 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 NIC Autotec if management cannot prevent a repeat of the 73% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since NIC Autotec 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. NIC Autotec 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, NIC Autotec's free cash flow amounted to 29% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case NIC Autotec has JP¥102.0m in net cash and a decent-looking balance sheet. So we don't have any problem with NIC Autotec's use of debt. 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. Case in point: We've spotted 4 warning signs for NIC Autotec you should be aware of, and 1 of them is potentially serious.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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