These 4 Measures Indicate That N2N Connect Berhad (KLSE:N2N) Is Using Debt Safely

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that N2N Connect Berhad (KLSE:N2N) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for N2N Connect Berhad

What Is N2N Connect Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that N2N Connect Berhad had RM13.8m of debt in September 2020, down from RM23.3m, one year before. However, its balance sheet shows it holds RM134.7m in cash, so it actually has RM120.9m net cash.

How Healthy Is N2N Connect Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that N2N Connect Berhad had liabilities of RM27.7m due within 12 months and liabilities of RM12.1m due beyond that. On the other hand, it had cash of RM134.7m and RM38.2m worth of receivables due within a year. So it can boast RM133.0m more liquid assets than total liabilities.

This excess liquidity is a great indication that N2N Connect Berhad's balance sheet is almost as strong as Fort Knox. 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 31% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if N2N Connect Berhad 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. N2N Connect Berhad 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. Over the most recent three years, N2N Connect Berhad recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that N2N Connect Berhad has net cash of RM120.9m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 31% over the last year. So is N2N Connect Berhad's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for N2N Connect Berhad 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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