We Think NEC (TSE:6701) Can Manage Its Debt With Ease

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.' 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 the real question is whether this debt is making the company risky.

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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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is NEC's Debt?

As you can see below, NEC had JP¥467.5b of debt at December 2024, down from JP¥499.4b a year prior. But it also has JP¥480.9b in cash to offset that, meaning it has JP¥13.5b net cash.

How Strong Is NEC's Balance Sheet?

The latest balance sheet data shows that NEC had liabilities of JP¥1.40t due within a year, and liabilities of JP¥664.7b falling due after that. On the other hand, it had cash of JP¥480.9b and JP¥561.0b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.02t.

While this might seem like a lot, it is not so bad since NEC has a huge market capitalization of JP¥3.56t, 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!

See our latest analysis for NEC

On top of that, NEC grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While NEC has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, NEC produced sturdy free cash flow equating to 62% 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

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¥13.5b. And it impressed us with its EBIT growth of 33% over the last year. So we don't think NEC's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for NEC 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.