Here's Why Sakurai (TYO:7255) Can Afford Some Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Sakurai Ltd. (TYO:7255) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Sakurai

What Is Sakurai's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Sakurai had JP¥1.69b of debt, an increase on JP¥1.60b, over one year. However, because it has a cash reserve of JP¥1.30b, its net debt is less, at about JP¥391.0m.

How Strong Is Sakurai's Balance Sheet?

We can see from the most recent balance sheet that Sakurai had liabilities of JP¥851.0m falling due within a year, and liabilities of JP¥1.92b due beyond that. On the other hand, it had cash of JP¥1.30b and JP¥491.0m worth of receivables due within a year. So it has liabilities totalling JP¥979.0m more than its cash and near-term receivables, combined.

Sakurai has a market capitalization of JP¥1.83b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is Sakurai'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.

In the last year Sakurai had a loss before interest and tax, and actually shrunk its revenue by 39%, to JP¥4.3b. That makes us nervous, to say the least.

Caveat Emptor

While Sakurai'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¥559m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled JP¥89m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. 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 instance, we've identified 3 warning signs for Sakurai that you should be aware of.

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.

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