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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Nel ASA (OB:NEL) 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 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, 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.
What Is Nel's Net Debt?
The image below, which you can click on for greater detail, shows that Nel had debt of kr21.8m at the end of March 2022, a reduction from kr28.5m over a year. However, it does have kr3.94b in cash offsetting this, leading to net cash of kr3.92b.
How Strong Is Nel's Balance Sheet?
We can see from the most recent balance sheet that Nel had liabilities of kr706.4m falling due within a year, and liabilities of kr260.0m due beyond that. Offsetting this, it had kr3.94b in cash and kr367.0m in receivables that were due within 12 months. So it actually has kr3.34b more liquid assets than total liabilities.
This surplus suggests that Nel is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Nel has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Nel'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.
Over 12 months, Nel reported revenue of kr805m, which is a gain of 33%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
So How Risky Is Nel?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Nel lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through kr786m of cash and made a loss of kr1.0b. But the saving grace is the kr3.92b on the balance sheet. That means it could keep spending at its current rate for more than two years. With very solid revenue growth in the last year, Nel may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. 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. Be aware that Nel is showing 4 warning signs in our investment analysis , you should know about...
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. 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.