Is Yorozu (TSE:7294) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Yorozu Corporation (TSE:7294) does carry debt. But should shareholders be worried about its use of debt?

Our free stock report includes 1 warning sign investors should be aware of before investing in Yorozu. Read for free now.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Yorozu Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Yorozu had JP¥36.0b of debt, an increase on JP¥33.9b, over one year. However, because it has a cash reserve of JP¥24.0b, its net debt is less, at about JP¥12.0b.

How Healthy Is Yorozu's Balance Sheet?

We can see from the most recent balance sheet that Yorozu had liabilities of JP¥44.5b falling due within a year, and liabilities of JP¥29.7b due beyond that. Offsetting this, it had JP¥24.0b in cash and JP¥28.3b in receivables that were due within 12 months. So it has liabilities totalling JP¥21.9b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of JP¥25.0b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

Check out our latest analysis for Yorozu

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Yorozu has net debt of just 0.90 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 7.8 times, which is more than adequate. On top of that, Yorozu grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Yorozu 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Yorozu burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Yorozu's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. We think that Yorozu's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Yorozu you should know about.

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.