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 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. As with many other companies National Research Corporation (NASDAQ:NRC) makes use of debt. 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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does National Research Carry?
As you can see below, National Research had US$30.6m of debt at December 2020, down from US$34.2m a year prior. But it also has US$34.7m in cash to offset that, meaning it has US$4.08m net cash.
A Look At National Research’s Liabilities
The latest balance sheet data shows that National Research had liabilities of US$31.7m due within a year, and liabilities of US$37.4m falling due after that. Offsetting these obligations, it had cash of US$34.7m as well as receivables valued at US$15.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$18.9m.
This state of affairs indicates that National Research’s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it’s very unlikely that the US$1.19b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, National Research boasts net cash, so it’s fair to say it does not have a heavy debt load!
While National Research doesn’t seem to have gained much on the EBIT line, at least earnings remain stable for now. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since National Research will need earnings to service that debt. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. National Research 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, National Research recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that National Research has US$4.08m in net cash. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in US$37m. So is National Research’s debt a risk? It doesn’t seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We’ve identified 2 warning signs with National Research , and understanding them should be part of your investment process.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
This article by Simply Wall St is general in nature. 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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