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 Nico Steel Holdings Limited (SGX:5GF) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Nico Steel Holdings Carry?
The chart below, which you can click on for greater detail, shows that Nico Steel Holdings had US$3.06m in debt in February 2019; about the same as the year before. However, its balance sheet shows it holds US$5.13m in cash, so it actually has US$2.07m net cash.
How Strong Is Nico Steel Holdings's Balance Sheet?
We can see from the most recent balance sheet that Nico Steel Holdings had liabilities of US$4.82m falling due within a year, and liabilities of US$9.9k due beyond that. Offsetting this, it had US$5.13m in cash and US$4.20m in receivables that were due within 12 months. So it can boast US$4.50m more liquid assets than total liabilities.
This surplus strongly suggests that Nico Steel Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Nico Steel Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Pleasingly, Nico Steel Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 1079% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nico Steel Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Nico Steel Holdings 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. During the last two years, Nico Steel Holdings produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Nico Steel Holdings has US$2.1m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 1079% over the last year. So is Nico Steel Holdings's debt a risk? It doesn't seem so to us. We'd be very excited to see if Nico Steel Holdings insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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