Does Mikikogyo (TYO:1718) Have A Healthy Balance Sheet?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Mikikogyo Co., Ltd. (TYO:1718) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Mikikogyo

What Is Mikikogyo's Debt?

The image below, which you can click on for greater detail, shows that Mikikogyo had debt of JP¥7.39b at the end of September 2020, a reduction from JP¥7.90b over a year. However, it does have JP¥4.02b in cash offsetting this, leading to net debt of about JP¥3.37b.

How Healthy Is Mikikogyo's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mikikogyo had liabilities of JP¥7.71b due within 12 months and liabilities of JP¥5.04b due beyond that. Offsetting these obligations, it had cash of JP¥4.02b as well as receivables valued at JP¥2.47b due within 12 months. So it has liabilities totalling JP¥6.26b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the JP¥4.06b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Mikikogyo would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Mikikogyo's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its commanding EBIT of 90.7 times its interest expense, implies the debt load is as light as a peacock feather. The bad news is that Mikikogyo saw its EBIT decline by 14% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mikikogyo 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Mikikogyo's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Mikikogyo's level of total liabilities was disappointing. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that Mikikogyo's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Mikikogyo you should be aware of, and 2 of them don't sit too well with us.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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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