Is DYNAM JAPAN HOLDINGS (HKG:6889) A Risky Investment?

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.' 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. Importantly, DYNAM JAPAN HOLDINGS Co., Ltd. (HKG:6889) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for DYNAM JAPAN HOLDINGS

What Is DYNAM JAPAN HOLDINGS's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 DYNAM JAPAN HOLDINGS had debt of JP¥35.2b, up from JP¥4.64b in one year. But it also has JP¥67.8b in cash to offset that, meaning it has JP¥32.6b net cash.

How Healthy Is DYNAM JAPAN HOLDINGS's Balance Sheet?

The latest balance sheet data shows that DYNAM JAPAN HOLDINGS had liabilities of JP¥62.7b due within a year, and liabilities of JP¥101.5b falling due after that. Offsetting these obligations, it had cash of JP¥67.8b as well as receivables valued at JP¥2.47b due within 12 months. So it has liabilities totalling JP¥93.9b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of JP¥80.4b, we think shareholders really should watch DYNAM JAPAN HOLDINGS's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Given that DYNAM JAPAN HOLDINGS has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Importantly, DYNAM JAPAN HOLDINGS's EBIT fell a jaw-dropping 65% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is DYNAM JAPAN HOLDINGS's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While DYNAM JAPAN 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. During the last three years, DYNAM JAPAN HOLDINGS generated free cash flow amounting to a very robust 97% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

Although DYNAM JAPAN HOLDINGS's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥32.6b. And it impressed us with free cash flow of JP¥7.8b, being 97% of its EBIT. So while DYNAM JAPAN HOLDINGS does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for DYNAM JAPAN HOLDINGS that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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