Is Nihon Plast (TSE:7291) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Nihon Plast Co., Ltd. (TSE:7291) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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.

Check out our latest analysis for Nihon Plast

How Much Debt Does Nihon Plast Carry?

You can click the graphic below for the historical numbers, but it shows that Nihon Plast had JP¥23.5b of debt in March 2024, down from JP¥30.3b, one year before. On the flip side, it has JP¥12.4b in cash leading to net debt of about JP¥11.1b.

A Look At Nihon Plast's Liabilities

The latest balance sheet data shows that Nihon Plast had liabilities of JP¥38.9b due within a year, and liabilities of JP¥12.0b falling due after that. Offsetting these obligations, it had cash of JP¥12.4b as well as receivables valued at JP¥17.9b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥20.5b.

The deficiency here weighs heavily on the JP¥6.15b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Nihon Plast would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 1.3 and interest cover of 4.5 times, it seems to us that Nihon Plast is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We also note that Nihon Plast improved its EBIT from a last year's loss to a positive JP¥2.8b. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nihon Plast will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Nihon Plast actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Neither Nihon Plast's ability to handle its total liabilities nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. When we consider all the factors discussed, it seems to us that Nihon Plast is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. For example, we've discovered 4 warning signs for Nihon Plast (1 shouldn't be ignored!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

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