Is Asahi Songwon Colors (NSE:ASAHISONG) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Asahi Songwon Colors Limited (NSE:ASAHISONG) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Asahi Songwon Colors

What Is Asahi Songwon Colors's Debt?

The image below, which you can click on for greater detail, shows that Asahi Songwon Colors had debt of ₹159.4m at the end of September 2020, a reduction from ₹406.1m over a year. However, it does have ₹118.7m in cash offsetting this, leading to net debt of about ₹40.7m.

How Healthy Is Asahi Songwon Colors's Balance Sheet?

According to the last reported balance sheet, Asahi Songwon Colors had liabilities of ₹430.2m due within 12 months, and liabilities of ₹249.3m due beyond 12 months. Offsetting this, it had ₹118.7m in cash and ₹445.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹115.7m.

Of course, Asahi Songwon Colors has a market capitalization of ₹2.94b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Asahi Songwon Colors has a very light debt load indeed.

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.

Asahi Songwon Colors has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.097 and EBIT of 16.3 times the interest expense. So relative to past earnings, the debt load seems trivial. Also positive, Asahi Songwon Colors grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Asahi Songwon Colors's earnings that will influence how the balance sheet holds up in the future. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Asahi Songwon Colors recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Asahi Songwon Colors's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Zooming out, Asahi Songwon Colors seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 example, we've discovered 2 warning signs for Asahi Songwon Colors that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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