Here’s why NagaCorp (HKG: 3918) has a heavy debt burden

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Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies NagaCorp Ltd. (HKG: 3918) uses debt. But should shareholders be concerned about its use of debt?

When is debt dangerous?

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. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.

Check out our latest analysis for NagaCorp

What is NagaCorp’s net debt?

You can click on the graph below for historical numbers, but it shows that as of June 2021, NagaCorp had $ 541.4 million in debt, an increase from $ 296.7 million, year over year. . However, he also had $ 302.7 million in cash, so his net debt is $ 238.7 million.

SEHK: 3918 History of debt to equity October 19, 2021

Is NagaCorp’s track record healthy?

Zooming in on the latest balance sheet data, we can see that NagaCorp had liabilities of US $ 257.2 million due within 12 months and liabilities of US $ 625.6 million beyond. On the other hand, he had $ 302.7 million in cash and $ 55.5 million in receivables within a year. It therefore has a liability totaling $ 524.6 million more than its cash and short-term receivables combined.

Given that NagaCorp has a market capitalization of US $ 4.00 billion, it is hard to believe that these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.

NagaCorp has a very low debt to EBITDA ratio of 1.3 so it is strange to see low interest coverage as last year’s EBIT was only 1.7 times interest expense. So while we are not necessarily alarmed, we think his debt is far from negligible. Shareholders should know that NagaCorp’s EBIT fell 75% last year. If this profit trend continues, paying off debt will be about as easy as driving cats on a roller coaster. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine NagaCorp’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

Finally, a business needs free cash flow to repay its 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, NagaCorp’s free cash flow has been 48% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.

Our point of view

While NagaCorp’s interest coverage makes us cautious about this, its track record of (not) growing its EBIT is no better. But it’s not so bad in managing its debt, based on its EBITDA. When we consider all the factors discussed, it seems to us that NagaCorp is taking risks with its use of debt. While this debt may increase returns, we believe the company now has sufficient leverage. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for NagaCorp you should know.

If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow net-growth stocks.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. 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 material. Simply Wall St has no position in the mentioned stocks.

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