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Is Northwest Pipe (NASDAQ:NWPX) A Risky Investment?

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·4 min read
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Northwest Pipe Company (NASDAQ:NWPX) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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.

See our latest analysis for Northwest Pipe

How Much Debt Does Northwest Pipe Carry?

As you can see below, at the end of December 2020, Northwest Pipe had US$13.6m of debt, up from none a year ago. Click the image for more detail. But it also has US$37.9m in cash to offset that, meaning it has US$24.3m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

How Healthy Is Northwest Pipe's Balance Sheet?

The latest balance sheet data shows that Northwest Pipe had liabilities of US$45.9m due within a year, and liabilities of US$57.5m falling due after that. Offsetting this, it had US$37.9m in cash and US$119.7m in receivables that were due within 12 months. So it actually has US$54.2m more liquid assets than total liabilities.

It's good to see that Northwest Pipe has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Northwest Pipe has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Northwest Pipe's EBIT dived 13%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Northwest Pipe can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Northwest Pipe 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. Happily for any shareholders, Northwest Pipe actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Northwest Pipe has US$24.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 132% of that EBIT to free cash flow, bringing in US$42m. So is Northwest Pipe's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Northwest Pipe , and understanding them should be part of your investment process.

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.

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.