Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Napco Security Technologies, Inc. (NASDAQ:NSSC) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Napco Security Technologies Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 Napco Security Technologies had US$3.90m of debt, an increase on none, over one year. However, it does have US$34.1m in cash offsetting this, leading to net cash of US$30.2m.
A Look At Napco Security Technologies’ Liabilities
We can see from the most recent balance sheet that Napco Security Technologies had liabilities of US$15.7m falling due within a year, and liabilities of US$10.7m due beyond that. On the other hand, it had cash of US$34.1m and US$22.4m worth of receivables due within a year. So it actually has US$30.0m more liquid assets than total liabilities.
This short term liquidity is a sign that Napco Security Technologies could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Napco Security Technologies boasts net cash, so it’s fair to say it does not have a heavy debt load!
In fact Napco Security Technologies’s saving grace is its low debt levels, because its EBIT has tanked 25% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Napco Security Technologies’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Napco Security Technologies has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Napco Security Technologies generated free cash flow amounting to a very robust 82% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company’s debt, in this case Napco Security Technologies has US$30.2m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$19m, being 82% of its EBIT. So we don’t have any problem with Napco Security Technologies’s use of debt. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. For example – Napco Security Technologies has 1 warning sign we think you should be aware of.
If, after all that, 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 without delay.
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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.
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