Is DENSO (TSE:6902) Using Too Much Debt?

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.' 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. We note that DENSO Corporation (TSE:6902) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 DENSO

What Is DENSO's Net Debt?

The image below, which you can click on for greater detail, shows that DENSO had debt of JP¥704.9b at the end of September 2024, a reduction from JP¥887.7b over a year. But on the other hand it also has JP¥1.11t in cash, leading to a JP¥401.5b net cash position.

How Healthy Is DENSO's Balance Sheet?

We can see from the most recent balance sheet that DENSO had liabilities of JP¥1.90t falling due within a year, and liabilities of JP¥1.01t due beyond that. Offsetting this, it had JP¥1.11t in cash and JP¥1.14t in receivables that were due within 12 months. So it has liabilities totalling JP¥652.4b more than its cash and near-term receivables, combined.

Of course, DENSO has a titanic market capitalization of JP¥6.68t, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, DENSO also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, DENSO's EBIT dived 13%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine DENSO's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. DENSO may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, DENSO recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about DENSO's liabilities, but we can be reassured by the fact it has has net cash of JP¥401.5b. So we don't have any problem with DENSO's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in DENSO, you may well want to click here to check an interactive graph of its earnings per share history.

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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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.