Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Car Mate Mfg. Co., Ltd. (TYO:7297) makes use of debt. But the real question is whether this debt is making the company risky.
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. 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 step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Car Mate Mfg
How Much Debt Does Car Mate Mfg Carry?
The image below, which you can click on for greater detail, shows that Car Mate Mfg had debt of JP¥1.31b at the end of December 2020, a reduction from JP¥1.44b over a year. But on the other hand it also has JP¥8.25b in cash, leading to a JP¥6.94b net cash position.
How Healthy Is Car Mate Mfg's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Car Mate Mfg had liabilities of JP¥3.82b due within 12 months and liabilities of JP¥2.54b due beyond that. Offsetting these obligations, it had cash of JP¥8.25b as well as receivables valued at JP¥3.88b due within 12 months. So it can boast JP¥5.77b more liquid assets than total liabilities.
This surplus liquidity suggests that Car Mate Mfg's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. 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 Car Mate Mfg has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Car Mate Mfg's saving grace is its low debt levels, because its EBIT has tanked 40% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Car Mate Mfg's earnings that will influence how the balance sheet holds up in the future. 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Car Mate Mfg 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. Over the most recent three years, Car Mate Mfg recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Car Mate Mfg has net cash of JP¥6.94b, as well as more liquid assets than liabilities. So is Car Mate Mfg's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Car Mate Mfg is showing 2 warning signs in our investment analysis , you should know about...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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:7297
Excellent balance sheet average dividend payer.
