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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that NICE Total Cash Management Co., Ltd (KOSDAQ:063570) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is NICE Total Cash Management's Net Debt?
As you can see below, at the end of December 2020, NICE Total Cash Management had ₩231.0b of debt, up from ₩216.2b a year ago. Click the image for more detail. However, it also had ₩176.5b in cash, and so its net debt is ₩54.5b.
A Look At NICE Total Cash Management's Liabilities
Zooming in on the latest balance sheet data, we can see that NICE Total Cash Management had liabilities of ₩225.8b due within 12 months and liabilities of ₩94.6b due beyond that. On the other hand, it had cash of ₩176.5b and ₩25.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩118.1b.
NICE Total Cash Management has a market capitalization of ₩202.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
NICE Total Cash Management has a very low debt to EBITDA ratio of 0.86 so it is strange to see weak interest coverage, with last year's EBIT being only 1.7 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that NICE Total Cash Management's EBIT was down 24% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine NICE Total Cash Management's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, NICE Total Cash Management saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
On the face of it, NICE Total Cash Management's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. We're quite clear that we consider NICE Total Cash Management to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example NICE Total Cash Management has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
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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