Natural Alternatives International (NASDAQ:NAII) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Natural Alternatives International, Inc. (NASDAQ:NAII) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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, 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 Natural Alternatives International

How Much Debt Does Natural Alternatives International Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Natural Alternatives International had US$10.0m of debt, an increase on none, over one year. However, its balance sheet shows it holds US$27.4m in cash, so it actually has US$17.4m net cash.

How Healthy Is Natural Alternatives International's Balance Sheet?

We can see from the most recent balance sheet that Natural Alternatives International had liabilities of US$37.1m falling due within a year, and liabilities of US$20.3m due beyond that. Offsetting these obligations, it had cash of US$27.4m as well as receivables valued at US$20.6m due within 12 months. So it has liabilities totalling US$9.43m more than its cash and near-term receivables, combined.

Since publicly traded Natural Alternatives International shares are worth a total of US$66.5m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Natural Alternatives International boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Natural Alternatives International's saving grace is its low debt levels, because its EBIT has tanked 65% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Natural Alternatives International 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. While Natural Alternatives International has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Natural Alternatives International saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While Natural Alternatives International does have more liabilities than liquid assets, it also has net cash of US$17.4m. So although we see some areas for improvement, we're not too worried about Natural Alternatives International's balance sheet. 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. For example, we've discovered 6 warning signs for Natural Alternatives International (1 is potentially serious!) 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. 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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