Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 NL Industries, Inc. (NYSE:NL) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is NL Industries's Debt?
As you can see below, NL Industries had US$500.0k of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. But on the other hand it also has US$128.6m in cash, leading to a US$128.1m net cash position.
How Healthy Is NL Industries's Balance Sheet?
The latest balance sheet data shows that NL Industries had liabilities of US$43.0m due within a year, and liabilities of US$219.2m falling due after that. Offsetting this, it had US$128.6m in cash and US$15.2m in receivables that were due within 12 months. So it has liabilities totalling US$118.4m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$179.9m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, NL Industries also has more cash than debt, so we're pretty confident it can manage its debt safely.
Even more impressive was the fact that NL Industries grew its EBIT by 118% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since NL Industries 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While NL Industries 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. Happily for any shareholders, NL Industries actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While NL Industries does have more liabilities than liquid assets, it also has net cash of US$128m. And it impressed us with free cash flow of US$19m, being 364% of its EBIT. So we don't think NL Industries's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that NL Industries insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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