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.' 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. Importantly, NIO Inc. (NYSE:NIO) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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, 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 NIO's Net Debt?
As you can see below, NIO had CN¥7.87b of debt at December 2020, down from CN¥8.36b a year prior. But it also has CN¥42.4b in cash to offset that, meaning it has CN¥34.6b net cash.
How Healthy Is NIO's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that NIO had liabilities of CN¥14.0b due within 12 months and liabilities of CN¥8.80b due beyond that. On the other hand, it had cash of CN¥42.4b and CN¥1.64b worth of receivables due within a year. So it actually has CN¥21.3b more liquid assets than total liabilities.
This surplus suggests that NIO has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that NIO has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if NIO can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, NIO reported revenue of CN¥16b, which is a gain of 108%, although it did not report any earnings before interest and tax. So there's no doubt that shareholders are cheering for growth
So How Risky Is NIO?
While NIO lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥823m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Keeping in mind its 108% revenue growth over the last year, we think there's a decent chance the company is on track. We'd see further strong growth as an optimistic indication. 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. Be aware that NIO is showing 2 warning signs in our investment analysis , and 1 of those is concerning...
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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