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.' 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 Mitsubishi Motors Corporation (TSE:7211) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Mitsubishi Motors
What Is Mitsubishi Motors's Debt?
The image below, which you can click on for greater detail, shows that Mitsubishi Motors had debt of JPÂ¥382.3b at the end of June 2024, a reduction from JPÂ¥438.4b over a year. But on the other hand it also has JPÂ¥562.0b in cash, leading to a JPÂ¥179.7b net cash position.
How Healthy Is Mitsubishi Motors' Balance Sheet?
According to the last reported balance sheet, Mitsubishi Motors had liabilities of JPÂ¥941.6b due within 12 months, and liabilities of JPÂ¥350.2b due beyond 12 months. Offsetting this, it had JPÂ¥562.0b in cash and JPÂ¥383.0b in receivables that were due within 12 months. So it has liabilities totalling JPÂ¥346.8b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Mitsubishi Motors is worth JPÂ¥635.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Mitsubishi Motors boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Mitsubishi Motors's EBIT dived 11%, 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 ultimately the future profitability of the business will decide if Mitsubishi Motors can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Mitsubishi Motors 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. In the last three years, Mitsubishi Motors's free cash flow amounted to 38% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While Mitsubishi Motors does have more liabilities than liquid assets, it also has net cash of JPÂ¥179.7b. So although we see some areas for improvement, we're not too worried about Mitsubishi Motors's balance sheet. 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 1 warning sign for Mitsubishi Motors that you should be aware of.
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.
About TSE:7211
Mitsubishi Motors
Engages in the development, production, and sale of passenger vehicles, and its parts and components in Japan, Europe, North America, Oceania, the rest of Asia, and internationally.
Undervalued with excellent balance sheet.