Is Toyo Tire (TSE:5105) A Risky Investment?

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.' 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. As with many other companies Toyo Tire Corporation (TSE:5105) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Toyo Tire

What Is Toyo Tire's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Toyo Tire had JP¥86.6b of debt, an increase on JP¥82.6b, over one year. But it also has JP¥86.6b in cash to offset that, meaning it has JP¥50.0m net cash.

How Strong Is Toyo Tire's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Toyo Tire had liabilities of JP¥150.9b due within 12 months and liabilities of JP¥99.2b due beyond that. On the other hand, it had cash of JP¥86.6b and JP¥129.3b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥34.2b.

Since publicly traded Toyo Tire shares are worth a total of JP¥406.0b, 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. While it does have liabilities worth noting, Toyo Tire also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, Toyo Tire grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Toyo Tire's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Toyo Tire 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. Looking at the most recent three years, Toyo Tire recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Toyo Tire's liabilities, but we can be reassured by the fact it has has net cash of JP¥50.0m. And we liked the look of last year's 22% year-on-year EBIT growth. So we don't have any problem with Toyo Tire'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 2 warning signs we've spotted with Toyo Tire (including 1 which can't be ignored) .

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. 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.