Here's Why Morimatsu International Holdings (HKG:2155) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Morimatsu International Holdings Company Limited (HKG:2155) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Morimatsu International Holdings

How Much Debt Does Morimatsu International Holdings Carry?

As you can see below, Morimatsu International Holdings had CN¥279.7m of debt at June 2024, down from CN¥399.8m a year prior. However, it does have CN¥2.40b in cash offsetting this, leading to net cash of CN¥2.12b.

A Look At Morimatsu International Holdings' Liabilities

According to the last reported balance sheet, Morimatsu International Holdings had liabilities of CN¥3.56b due within 12 months, and liabilities of CN¥273.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.40b as well as receivables valued at CN¥2.38b due within 12 months. So it actually has CN¥944.1m more liquid assets than total liabilities.

This surplus suggests that Morimatsu International Holdings is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Morimatsu International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Morimatsu International Holdings saw its EBIT drop by 9.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Morimatsu International Holdings 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Morimatsu International Holdings 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. In the last three years, Morimatsu International Holdings's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Morimatsu International Holdings has CN¥2.12b in net cash and a decent-looking balance sheet. So we are not troubled with Morimatsu International Holdings's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Morimatsu International Holdings you should be aware of, and 1 of them is potentially serious.

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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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.