Does National Aerospace Fasteners (TWSE:3004) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 National Aerospace Fasteners Corporation (TWSE:3004) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for National Aerospace Fasteners

What Is National Aerospace Fasteners's Net Debt?

You can click the graphic below for the historical numbers, but it shows that National Aerospace Fasteners had NT$1.85b of debt in December 2023, down from NT$1.98b, one year before. However, because it has a cash reserve of NT$105.1m, its net debt is less, at about NT$1.74b.

A Look At National Aerospace Fasteners' Liabilities

Zooming in on the latest balance sheet data, we can see that National Aerospace Fasteners had liabilities of NT$1.28b due within 12 months and liabilities of NT$1.47b due beyond that. Offsetting this, it had NT$105.1m in cash and NT$730.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.91b.

National Aerospace Fasteners has a market capitalization of NT$5.99b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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

National Aerospace Fasteners has a debt to EBITDA ratio of 3.0, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 10.8 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Notably, National Aerospace Fasteners's EBIT launched higher than Elon Musk, gaining a whopping 171% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since National Aerospace Fasteners 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last two years, National Aerospace Fasteners's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, National Aerospace Fasteners's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. All these things considered, it appears that National Aerospace Fasteners can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for National Aerospace Fasteners (of which 2 are a bit concerning!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.