Legendary fund manager Li Lu (who was assisted by Charlie Munger) once said: “The greatest risk to investment is not price volatility, but whether you suffer permanent capital loss.” So it might be obvious that you need to consider debt when thinking about how risky a particular stock is, as too much debt can bring a company down. We can see that Nagreeka Exports Limited (NSE: NAGREEKEXP) uses debt in its business. But the more important question is, what is the risk this debt entails?
When is debt dangerous?
Debt and other liabilities become risky for a company when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. When things get really bad, lenders can take control of the business. However, a more common (but still costly) occurrence is when a company has to issue stocks at bargain prices, which permanently dilutes shareholders just to prop up its balance sheet. Of course, debt can be an important tool in any business, especially in capital-intensive companies. When we think about using a company’s debt, let’s first look at cash and debt together.
Check out our latest analysis for Nagreeka Exports
What is Nagreeka Exports’ net debt?
As you can see below, Nagreeka Exports had a debt of 1.93 billion yen in March 2021, which is roughly the same as last year. You can click the diagram for more information. However, this is offset by 48.2 million in cash, resulting in a net debt of approximately 1.88 billion.
A look at Nagreeka Exports’ liabilities
According to the most recently published balance sheet, Nagreeka Exports had liabilities of 1.98 billion due within 12 months and liabilities of 532.9 million due beyond 12 months. This was offset by 48.2 million cash and 248.8 million receivables that were due within 12 months. So its liabilities are 2.21 billion more than the combination of cash and short-term receivables.
This deficit casts a shadow over the 412.5-meter company, like a colossus towering over mere mortals. We therefore believe that shareholders should watch this closely. At the end of the day, Nagreeka Exports would likely need a major recapitalization if its creditors demanded repayment.
We use two main metrics to help us understand debt versus revenue. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), and the second is how often earnings before interest and taxes (EBIT) cover its interest expense (or interest coverage for short). . We therefore look at debt in relation to earnings, both with and without depreciation and amortization.
Nagreeka Exports shareholders are faced with a high net debt to EBITDA ratio (25.9) and relatively poor interest coverage as EBIT is only 0.0028 times the interest expense. This means that we would consider it a heavy debt burden. Worse still, Nagreeka Exports has seen an EBIT tank of 100% for the past 12 months. If the revenue continues like this in the long run, there is a hell of a chance of paying off that debt. Undoubtedly, we learn the most about balance sheet debt. But it is Nagreeka Exports’ income that will influence future balance sheet developments. So when looking at debt, it’s definitely worth taking a look at earnings trends. Click here for an interactive snapshot.
But our final consideration is also important because a company cannot pay its debts with paper profits; it takes cold cash. So the logical step is to look at the portion of this EBIT that corresponds to the actual free cash flow. For the past three years Nagreeka Exports has posted free cash flow of 12% of its EBIT, which is really quite low. This weak cash conversion undermines its ability to manage and pay off debt.
At first glance, Nagreeka Exports’ EBIT growth rate on the stock made us hesitant, and the level of total debt was no more enticing than that one empty restaurant on the busiest night of the year. And even net debt to EBITDA doesn’t inspire much confidence. Given all of what we mentioned above, it is fair to say that Nagreeka Exports has a heavy debt burden. If you harvest honey without a bee suit, you run the risk of being stung, so we’d probably stay away from this particular stock. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, any business can involve off-balance sheet risks. Case in point: we have discovered 4 warning signs for Nagreeka exports You should be aware of this and 3 of them should not be ignored.
After all that, if 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 right now.
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