David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, NCC AB (publ) (STO:NCC B) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. 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. 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 NCC's Net Debt?
As you can see below, NCC had kr1.92b of debt at March 2021, down from kr2.50b a year prior. But it also has kr3.05b in cash to offset that, meaning it has kr1.12b net cash.
How Healthy Is NCC's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that NCC had liabilities of kr15.5b due within 12 months and liabilities of kr9.23b due beyond that. Offsetting these obligations, it had cash of kr3.05b as well as receivables valued at kr8.92b due within 12 months. So its liabilities total kr12.8b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of kr16.2b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, NCC also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, NCC's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if NCC can strengthen its balance sheet over time. 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 NCC 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 last two years, NCC actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Although NCC's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of kr1.12b. The cherry on top was that in converted 105% of that EBIT to free cash flow, bringing in kr523m. So we don't have any problem with NCC's use of debt. 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. For instance, we've identified 3 warning signs for NCC (1 is a bit unpleasant) 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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