NEC (TSE:6701) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that NEC Corporation (TSE:6701) 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?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for NEC

What Is NEC's Debt?

You can click the graphic below for the historical numbers, but it shows that NEC had JP¥438.8b of debt in September 2024, down from JP¥467.8b, one year before. But on the other hand it also has JP¥484.0b in cash, leading to a JP¥45.2b net cash position.

How Strong Is NEC's Balance Sheet?

According to the last reported balance sheet, NEC had liabilities of JP¥1.29t due within 12 months, and liabilities of JP¥709.6b due beyond 12 months. Offsetting this, it had JP¥484.0b in cash and JP¥500.6b in receivables that were due within 12 months. So it has liabilities totalling JP¥1.01t more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since NEC has a huge market capitalization of JP¥3.59t, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, NEC boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that NEC grew its EBIT by 11% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if NEC can strengthen its balance sheet over time. 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 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although NEC's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥45.2b. And it impressed us with free cash flow of JP¥198b, being 67% of its EBIT. So is NEC's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of NEC's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.