Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Naga Corp Ltd. (HKG:3918) uses debt in his business. But should shareholders worry about its use of debt?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
See our latest analysis for NagaCorp
What is NagaCorp’s debt?
As you can see below, NagaCorp had US$543.0 million in debt as of December 2021, up from US$635.6 million the previous year. However, he also had $124.3 million in cash, so his net debt is $418.7 million.
How strong is NagaCorp’s balance sheet?
The latest balance sheet data shows that NagaCorp had liabilities of $151.4 million due within the year, and liabilities of $626.2 million due thereafter. On the other hand, it had liquidities of 124.3 million dollars and 39.6 million dollars of receivables within one year. Thus, its liabilities total $613.7 million more than the combination of its cash and short-term receivables.
Given that NagaCorp has a market capitalization of US$3.88 billion, it’s hard to believe that these liabilities pose a big threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine NagaCorp’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Last year, NagaCorp posted a loss before interest and taxes and actually cut its revenue by 76%, to $214 million. It makes us nervous, to say the least.
While NagaCorp’s declining revenue is about as comforting as a wet blanket, its earnings before interest and taxes (EBIT) are arguably even less appealing. To be precise, the EBIT loss amounted to 104 million US dollars. Considering that alongside the liabilities mentioned above, this doesn’t give us much confidence that the company should use so much debt. So we think its balance sheet is a little stretched, but not beyond repair. Another reason for caution is that it has lost $114 million in negative free cash flow over the past twelve months. So suffice it to say that we consider the stock to be risky. When I consider a company to be a bit risky, I think it is their responsibility to check whether insiders have reported stock sales. Fortunately, you can click here to view our chart illustrating NagaCorp’s insider trading.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.