Here's Why NEXCOM International (GTSM:8234) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that NEXCOM International Co., Ltd. (GTSM:8234) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for NEXCOM International

What Is NEXCOM International's Net Debt?

As you can see below, NEXCOM International had NT$2.28b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have NT$1.06b in cash offsetting this, leading to net debt of about NT$1.22b.

How Healthy Is NEXCOM International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NEXCOM International had liabilities of NT$3.64b due within 12 months and liabilities of NT$223.4m due beyond that. Offsetting these obligations, it had cash of NT$1.06b as well as receivables valued at NT$1.38b due within 12 months. So it has liabilities totalling NT$1.42b more than its cash and near-term receivables, combined.

This deficit isn't so bad because NEXCOM International is worth NT$3.47b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

NEXCOM International has net debt to EBITDA of 3.1 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 8.5 times its interest expense, and its net debt to EBITDA, was quite high, at 3.1. We saw NEXCOM International grow its EBIT by 5.3% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But it is NEXCOM International's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, NEXCOM International recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

NEXCOM International's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. Looking at all the aforementioned factors together, it strikes us that NEXCOM International can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for NEXCOM International (of which 1 shouldn't be ignored!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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.
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