In This Article:
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, NEXTDC Limited (ASX:NXT) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for NEXTDC
What Is NEXTDC's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 NEXTDC had debt of AU$793.8m, up from AU$303.0m in one year. However, it does have AU$399.0m in cash offsetting this, leading to net debt of about AU$394.9m.
A Look At NEXTDC's Liabilities
The latest balance sheet data shows that NEXTDC had liabilities of AU$63.5m due within a year, and liabilities of AU$887.1m falling due after that. Offsetting these obligations, it had cash of AU$399.0m as well as receivables valued at AU$33.9m due within 12 months. So it has liabilities totalling AU$517.7m more than its cash and near-term receivables, combined.
This deficit isn't so bad because NEXTDC is worth AU$2.11b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 0.78 times and a disturbingly high net debt to EBITDA ratio of 5.1 hit our confidence in NEXTDC like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. On the other hand, NEXTDC grew its EBIT by 28% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if NEXTDC can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.