Here's Why Napco Security Technologies (NASDAQ:NSSC) Can Manage Its Debt Responsibly
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.' 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 note that Napco Security Technologies, Inc. (NASDAQ:NSSC) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Napco Security Technologies
How Much Debt Does Napco Security Technologies Carry?
As you can see below, at the end of December 2020, Napco Security Technologies had US$3.90m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds US$26.8m in cash, so it actually has US$22.9m net cash.
How Strong Is Napco Security Technologies' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Napco Security Technologies had liabilities of US$13.5m due within 12 months and liabilities of US$11.2m due beyond that. On the other hand, it had cash of US$26.8m and US$21.2m worth of receivables due within a year. So it actually has US$23.3m more liquid assets than total liabilities.
This surplus suggests that Napco Security Technologies has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Napco Security Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Napco Security Technologies's load is not too heavy, because its EBIT was down 29% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Napco Security Technologies's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Napco Security Technologies 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 most recent three years, Napco Security Technologies recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Napco Security Technologies has net cash of US$22.9m, as well as more liquid assets than liabilities. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in US$13m. So we are not troubled with Napco Security Technologies's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Napco Security Technologies is showing 3 warning signs in our investment analysis , you should know about...
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.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
