Here's Why NEUCA (WSE:NEU) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that NEUCA S.A. (WSE:NEU) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for NEUCA

What Is NEUCA's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 NEUCA had debt of zł521.1m, up from zł232.3m in one year. However, it does have zł108.2m in cash offsetting this, leading to net debt of about zł412.9m.

A Look At NEUCA's Liabilities

According to the last reported balance sheet, NEUCA had liabilities of zł3.91b due within 12 months, and liabilities of zł357.5m due beyond 12 months. Offsetting this, it had zł108.2m in cash and zł1.82b in receivables that were due within 12 months. So it has liabilities totalling zł2.34b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of zł3.71b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While NEUCA's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.6 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Sadly, NEUCA's EBIT actually dropped 7.7% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if NEUCA 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, NEUCA recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

On our analysis NEUCA's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to grow its EBIT. It's also worth noting that NEUCA is in the Healthcare industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about NEUCA's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with NEUCA , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.