We Think Koito Manufacturing (TSE:7276) Can Stay On Top Of Its Debt

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 can see that Koito Manufacturing Co., Ltd. (TSE:7276) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Koito Manufacturing

What Is Koito Manufacturing's Net Debt?

The image below, which you can click on for greater detail, shows that Koito Manufacturing had debt of JP¥10.2b at the end of September 2024, a reduction from JP¥19.8b over a year. But it also has JP¥280.2b in cash to offset that, meaning it has JP¥270.1b net cash.

A Look At Koito Manufacturing's Liabilities

Zooming in on the latest balance sheet data, we can see that Koito Manufacturing had liabilities of JP¥171.1b due within 12 months and liabilities of JP¥38.6b due beyond that. Offsetting these obligations, it had cash of JP¥280.2b as well as receivables valued at JP¥125.3b due within 12 months. So it actually has JP¥195.8b more liquid assets than total liabilities.

This luscious liquidity implies that Koito Manufacturing's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Koito Manufacturing has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Koito Manufacturing's saving grace is its low debt levels, because its EBIT has tanked 30% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Koito Manufacturing'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Koito Manufacturing 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, Koito Manufacturing recorded free cash flow worth 69% 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 Koito Manufacturing has net cash of JP¥270.1b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥43b, being 69% of its EBIT. So is Koito Manufacturing's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Koito Manufacturing 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. 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.