Is NEUCA (WSE: NEU) using too much debt?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that NEUCA SA (WSE: NEU) uses debt in its business. But should shareholders be concerned about its use of debt?
When is debt a problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we look at debt levels, we first consider both liquidity and debt levels.
Discover our latest analysis for NEUCA
What is NEUCA’s debt?
As you can see below, NEUCA had a debt of Z 180.4million in March 2021, up from Z 290.9million a year earlier. However, he also had Z26.8million in cash, so his net debt is Z153.5million.
A look at NEUCA’s liabilities
According to the latest published balance sheet, NEUCA had liabilities of Z 2.44 billion due within 12 months and liabilities of Z 295.2 million due beyond 12 months. On the other hand, he had cash of Z26.8 million and Z1.27 billion of receivables due within one year. It therefore has liabilities totaling Z 1.44 billion more than its combined cash and short-term receivables.
While this may sound like a lot, it is not that big of a deal since NEUCA has a market cap of 3.51z, and could therefore probably strengthen its balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
NEUCA has net debt of only 0.52 times EBITDA, which suggests it could increase its leverage without breaking a sweat. And remarkably, despite her net debt, she actually received more interest in the past twelve months than she had to pay. So it’s fair to say he can handle debt like a hot teppanyaki chef handles the kitchen. And we also warmly note that NEUCA increased its EBIT by 18% last year, which makes its debt more manageable. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether NEUCA can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, NEUCA has generated strong free cash flow equivalent to 60% of its EBIT, which we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Fortunately, NEUCA’s impressive interest coverage means it has the upper hand over its debt. And the good news does not end there, since its net debt to EBITDA also confirms this impression! It should also be noted that companies in the health sector like NEUCA routinely use debt without any problem. Considering all this data, it seems to us that NEUCA is taking a fairly sensible approach to debt. While this carries some risk, it can also improve returns for shareholders. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. We have identified 1 warning sign with NEUCA, and understanding them should be part of your investment process.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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