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 note that Nixu Oyj (HEL:NIXU) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Nixu Oyj's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Nixu Oyj had debt of €9.87m, up from €8.06m in one year. On the flip side, it has €5.14m in cash leading to net debt of about €4.73m.
How Healthy Is Nixu Oyj's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Nixu Oyj had liabilities of €16.4m due within 12 months and liabilities of €8.93m due beyond that. Offsetting this, it had €5.14m in cash and €15.4m in receivables that were due within 12 months. So its liabilities total €4.85m more than the combination of its cash and short-term receivables.
Of course, Nixu Oyj has a market capitalization of €91.5m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While we wouldn't worry about Nixu Oyj's net debt to EBITDA ratio of 2.5, we think its super-low interest cover of 2.1 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. One redeeming factor for Nixu Oyj is that it turned last year's EBIT loss into a gain of €1.1m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Nixu Oyj can strengthen its balance sheet over time. 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Nixu Oyj barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.
Both Nixu Oyj's interest cover and its conversion of EBIT to free cash flow were discouraging. But its not so bad at staying on top of its total liabilities. When we consider all the factors discussed, it seems to us that Nixu Oyj is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. Even though Nixu Oyj lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.