David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that NARI Technology Co., Ltd. (SHSE:600406) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is NARI Technology's Debt?
The image below, which you can click on for greater detail, shows that NARI Technology had debt of CN¥618.2m at the end of March 2024, a reduction from CN¥1.39b over a year. However, its balance sheet shows it holds CN¥20.6b in cash, so it actually has CN¥20.0b net cash.
How Healthy Is NARI Technology's Balance Sheet?
The latest balance sheet data shows that NARI Technology had liabilities of CN¥31.6b due within a year, and liabilities of CN¥616.4m falling due after that. Offsetting this, it had CN¥20.6b in cash and CN¥30.1b in receivables that were due within 12 months. So it actually has CN¥18.5b more liquid assets than total liabilities.
This surplus suggests that NARI Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, NARI Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that NARI Technology has increased its EBIT by 7.9% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if NARI Technology 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. NARI Technology 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. Over the last three years, NARI Technology recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that NARI Technology has net cash of CN¥20.0b, as well as more liquid assets than liabilities. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in CN¥11b. So we don't think NARI Technology's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for NARI Technology that you should be aware of.
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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.