Is Tanaka Seimitsu Kogyo (TYO:7218) Weighed On By Its Debt Load?

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. As with many other companies Tanaka Seimitsu Kogyo Co., Ltd. (TYO:7218) makes use of debt. But should shareholders be worried about its use of debt?

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 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. 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 Tanaka Seimitsu Kogyo

How Much Debt Does Tanaka Seimitsu Kogyo Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Tanaka Seimitsu Kogyo had debt of JP¥10.8b, up from JP¥8.85b in one year. On the flip side, it has JP¥5.85b in cash leading to net debt of about JP¥4.93b.

A Look At Tanaka Seimitsu Kogyo's Liabilities

We can see from the most recent balance sheet that Tanaka Seimitsu Kogyo had liabilities of JP¥10.9b falling due within a year, and liabilities of JP¥4.83b due beyond that. On the other hand, it had cash of JP¥5.85b and JP¥2.83b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥7.02b.

When you consider that this deficiency exceeds the company's JP¥5.83b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Tanaka Seimitsu Kogyo will need earnings to service that debt. 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.

In the last year Tanaka Seimitsu Kogyo had a loss before interest and tax, and actually shrunk its revenue by 28%, to JP¥26b. That makes us nervous, to say the least.

Caveat Emptor

While Tanaka Seimitsu Kogyo's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable JP¥1.8b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through JP¥2.3b in negative free cash flow over the last year. That means it's on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Tanaka Seimitsu Kogyo (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. 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.
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