Nordic Group (SGX:MR7) Seems To Use Debt Quite Sensibly

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 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, Nordic Group Limited (SGX:MR7) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Nordic Group

What Is Nordic Group's Net Debt?

As you can see below, at the end of December 2020, Nordic Group had S$45.9m of debt, up from S$41.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds S$57.5m in cash, so it actually has S$11.6m net cash.

How Healthy Is Nordic Group's Balance Sheet?

We can see from the most recent balance sheet that Nordic Group had liabilities of S$67.0m falling due within a year, and liabilities of S$12.2m due beyond that. On the other hand, it had cash of S$57.5m and S$21.4m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

Having regard to Nordic Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the S$99.0m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Nordic Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Nordic Group's EBIT fell a jaw-dropping 59% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nordic Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Nordic Group 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 three years, Nordic Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

We could understand if investors are concerned about Nordic Group's liabilities, but we can be reassured by the fact it has has net cash of S$11.6m. The cherry on top was that in converted 130% of that EBIT to free cash flow, bringing in S$17m. So we don't have any problem with Nordic Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 5 warning signs for Nordic Group (1 is a bit unpleasant) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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