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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Muro Corporation (TYO:7264) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Muro
What Is Muro's Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Muro had debt of JP¥2.90b, up from JP¥1.02b in one year. However, its balance sheet shows it holds JP¥7.61b in cash, so it actually has JP¥4.70b net cash.
How Strong Is Muro's Balance Sheet?
We can see from the most recent balance sheet that Muro had liabilities of JP¥8.20b falling due within a year, and liabilities of JP¥735.0m due beyond that. On the other hand, it had cash of JP¥7.61b and JP¥4.82b worth of receivables due within a year. So it actually has JP¥3.50b more liquid assets than total liabilities.
This surplus strongly suggests that Muro has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Muro has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Muro if management cannot prevent a repeat of the 38% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Muro will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Muro 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, Muro's free cash flow amounted to 45% 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 Muro has JP¥4.70b in net cash and a decent-looking balance sheet. So we don't have any problem with Muro's use of debt. 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. To that end, you should learn about the 4 warning signs we've spotted with Muro (including 1 which is potentially serious) .
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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About TSE:7264
Excellent balance sheet average dividend payer.
