Is N2N Connect Berhad (KLSE:N2N) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies N2N Connect Berhad (KLSE:N2N) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for N2N Connect Berhad

How Much Debt Does N2N Connect Berhad Carry?

As you can see below, N2N Connect Berhad had RM11.2m of debt at December 2020, down from RM20.5m a year prior. But it also has RM133.4m in cash to offset that, meaning it has RM122.3m net cash.

A Look At N2N Connect Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that N2N Connect Berhad had liabilities of RM24.9m due within 12 months and liabilities of RM7.01m due beyond that. Offsetting these obligations, it had cash of RM133.4m as well as receivables valued at RM27.4m due within 12 months. So it actually has RM128.9m more liquid assets than total liabilities.

This luscious liquidity implies that N2N Connect Berhad's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that N2N Connect Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, N2N Connect Berhad grew its EBIT by 41% 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 N2N Connect Berhad'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. While N2N Connect Berhad 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. Over the most recent three years, N2N Connect Berhad recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that N2N Connect Berhad has net cash of RM122.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 41% over the last year. So we don't think N2N Connect Berhad's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for N2N Connect Berhad that you should be aware of.

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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