Here's Why NEC (TSE:6701) Can Manage Its Debt Responsibly

Warren Buffett famously said, '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 can see that NEC Corporation (TSE:6701) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for NEC

What Is NEC's Debt?

The image below, which you can click on for greater detail, shows that NEC had debt of JP¥382.9b at the end of March 2024, a reduction from JP¥451.7b over a year. But it also has JP¥492.2b in cash to offset that, meaning it has JP¥109.3b net cash.

How Healthy Is NEC's Balance Sheet?

The latest balance sheet data shows that NEC had liabilities of JP¥1.47t due within a year, and liabilities of JP¥668.6b falling due after that. Offsetting this, it had JP¥492.2b in cash and JP¥829.5b in receivables that were due within 12 months. So it has liabilities totalling JP¥816.3b more than its cash and near-term receivables, combined.

NEC has a very large market capitalization of JP¥3.40t, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, NEC boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that NEC grew its EBIT at 10% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine NEC's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. NEC 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. During the last three years, NEC produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While NEC does have more liabilities than liquid assets, it also has net cash of JP¥109.3b. So is NEC's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in NEC, you may well want to click here to check an interactive graph of its earnings per share history.

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. 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.

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