Is Natural Alternatives International (NASDAQ:NAII) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Natural Alternatives International, Inc. (NASDAQ:NAII) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Natural Alternatives International

What Is Natural Alternatives International's Net Debt?

As you can see below, Natural Alternatives International had US$9.37m of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has US$16.6m in cash to offset that, meaning it has US$7.22m net cash.

How Strong Is Natural Alternatives International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Natural Alternatives International had liabilities of US$13.4m due within 12 months and liabilities of US$56.9m due beyond that. On the other hand, it had cash of US$16.6m and US$11.3m worth of receivables due within a year. So its liabilities total US$42.3m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$36.9m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Given that Natural Alternatives International has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Natural Alternatives International 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.

Over 12 months, Natural Alternatives International made a loss at the EBIT level, and saw its revenue drop to US$128m, which is a fall of 29%. To be frank that doesn't bode well.

So How Risky Is Natural Alternatives International?

While Natural Alternatives International lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$4.5m. 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. We're not impressed by its revenue growth, so until we see some positive sustainable EBIT, we consider the stock to be high risk. 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 Natural Alternatives International (1 doesn't sit too well with us!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.