David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Gas Services Group, Inc. (NYSE:NGS) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Natural Gas Services Group's Debt?
The chart below, which you can click on for greater detail, shows that Natural Gas Services Group had US$417.0k in debt in June 2019; about the same as the year before. However, it does have US$29.9m in cash offsetting this, leading to net cash of US$29.5m.
A Look At Natural Gas Services Group's Liabilities
We can see from the most recent balance sheet that Natural Gas Services Group had liabilities of US$6.82m falling due within a year, and liabilities of US$35.2m due beyond that. Offsetting this, it had US$29.9m in cash and US$11.4m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.
This state of affairs indicates that Natural Gas Services Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$152.9m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Natural Gas Services Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
It is just as well that Natural Gas Services Group's load is not too heavy, because its EBIT was down 38% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Natural Gas Services Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Natural Gas Services Group 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 Gas Services Group 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.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Natural Gas Services Group has US$29m in net cash. So while Natural Gas Services Group does not have a great balance sheet, it's certainly not too bad. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
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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