Is NGS Group (STO:NGS) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, NGS Group AB (publ) (STO:NGS) does carry debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that NGS is potentially undervalued!

What Is NGS Group's Net Debt?

The image below, which you can click on for greater detail, shows that NGS Group had debt of kr19.7m at the end of June 2022, a reduction from kr34.3m over a year. However, it does have kr1.90m in cash offsetting this, leading to net debt of about kr17.8m.

How Healthy Is NGS Group's Balance Sheet?

We can see from the most recent balance sheet that NGS Group had liabilities of kr98.4m falling due within a year, and liabilities of kr4.11m due beyond that. Offsetting this, it had kr1.90m in cash and kr59.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr41.1m.

This deficit isn't so bad because NGS Group is worth kr129.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

NGS Group has a low net debt to EBITDA ratio of only 0.72. And its EBIT covers its interest expense a whopping 15.0 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that NGS Group has boosted its EBIT by 77%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since NGS Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Happily for any shareholders, NGS Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

NGS Group's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It's also worth noting that NGS Group is in the Healthcare industry, which is often considered to be quite defensive. Overall, we don't think NGS Group is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for NGS Group (1 can't be ignored!) that you should be aware of before investing here.

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.