These 4 Measures Indicate That Nextronics Engineering (GTSM:8147) Is Using Debt Reasonably Well

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, Nextronics Engineering Corp. (GTSM:8147) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Nextronics Engineering

What Is Nextronics Engineering's Net Debt?

As you can see below, at the end of September 2020, Nextronics Engineering had NT$135.9m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has NT$374.9m in cash, leading to a NT$239.0m net cash position.

How Strong Is Nextronics Engineering's Balance Sheet?

According to the last reported balance sheet, Nextronics Engineering had liabilities of NT$272.7m due within 12 months, and liabilities of NT$104.4m due beyond 12 months. Offsetting these obligations, it had cash of NT$374.9m as well as receivables valued at NT$202.8m due within 12 months. So it actually has NT$200.5m more liquid assets than total liabilities.

This surplus suggests that Nextronics Engineering is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Nextronics Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Nextronics Engineering made a loss at the EBIT level, last year, it was also good to see that it generated NT$20m in EBIT over the last twelve months. 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 Nextronics Engineering 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 company can only pay off debt with cold hard cash, not accounting profits. Nextronics Engineering may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Nextronics Engineering recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Nextronics Engineering has net cash of NT$239.0m, as well as more liquid assets than liabilities. So we don't have any problem with Nextronics Engineering'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 example, we've discovered 2 warning signs for Nextronics Engineering (1 can't be ignored!) that you should be aware of before investing here.

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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