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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Nera Telecommunications Ltd (SGX:N01) does have debt on its balance sheet. 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, 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.
What Is Nera Telecommunications's Debt?
The image below, which you can click on for greater detail, shows that at June 2020 Nera Telecommunications had debt of S$34.0m, up from S$11.9m in one year. However, it also had S$25.6m in cash, and so its net debt is S$8.38m.
A Look At Nera Telecommunications's Liabilities
Zooming in on the latest balance sheet data, we can see that Nera Telecommunications had liabilities of S$102.0m due within 12 months and liabilities of S$4.37m due beyond that. On the other hand, it had cash of S$25.6m and S$126.4m worth of receivables due within a year. So it can boast S$45.6m more liquid assets than total liabilities.
This luscious liquidity implies that Nera Telecommunications's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master.
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.
We'd say that Nera Telecommunications's moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its commanding EBIT of 11.3 times its interest expense, implies the debt load is as light as a peacock feather. It is just as well that Nera Telecommunications's load is not too heavy, because its EBIT was down 52% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nera Telecommunications 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Nera Telecommunications saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Nera Telecommunications's EBIT growth rate was a real negative on this analysis, as was its conversion of EBIT to free cash flow. But like a ballerina ending on a perfect pirouette, it has not trouble staying on top of its total liabilities. Considering this range of data points, we think Nera Telecommunications is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Nera Telecommunications (2 make us uncomfortable) you should be aware of.
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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