We Think Tokyo Plast International (NSE:TOKYOPLAST) Is Taking Some Risk With Its 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.' 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. As with many other companies Tokyo Plast International Limited (NSE:TOKYOPLAST) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tokyo Plast International

How Much Debt Does Tokyo Plast International Carry?

As you can see below, at the end of September 2021, Tokyo Plast International had ₹180.8m of debt, up from ₹89.7m a year ago. Click the image for more detail. However, it does have ₹7.43m in cash offsetting this, leading to net debt of about ₹173.4m.

How Healthy Is Tokyo Plast International's Balance Sheet?

According to the last reported balance sheet, Tokyo Plast International had liabilities of ₹284.0m due within 12 months, and liabilities of ₹54.3m due beyond 12 months. Offsetting this, it had ₹7.43m in cash and ₹226.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹104.0m.

Since publicly traded Tokyo Plast International shares are worth a total of ₹987.7m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Tokyo Plast International's debt is 3.3 times its EBITDA, and its EBIT cover its interest expense 3.8 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, the silver lining was that Tokyo Plast International achieved a positive EBIT of ₹28m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tokyo Plast International'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Tokyo Plast International burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Tokyo Plast International's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its level of total liabilities is relatively strong. Taking the abovementioned factors together we do think Tokyo Plast International's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. For example, we've discovered 2 warning signs for Tokyo Plast International (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.