Is Taiyo KisokogyoLtd (TYO:1758) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Taiyo Kisokogyo Co.,Ltd. (TYO:1758) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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 Taiyo KisokogyoLtd

What Is Taiyo KisokogyoLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Taiyo KisokogyoLtd had JP¥170.0m of debt in October 2020, down from JP¥257.0m, one year before. But on the other hand it also has JP¥2.11b in cash, leading to a JP¥1.94b net cash position.

A Look At Taiyo KisokogyoLtd's Liabilities

According to the last reported balance sheet, Taiyo KisokogyoLtd had liabilities of JP¥2.61b due within 12 months, and liabilities of JP¥497.0m due beyond 12 months. Offsetting these obligations, it had cash of JP¥2.11b as well as receivables valued at JP¥3.64b due within 12 months. So it can boast JP¥2.64b more liquid assets than total liabilities.

This luscious liquidity implies that Taiyo KisokogyoLtd's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Taiyo KisokogyoLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Taiyo KisokogyoLtd if management cannot prevent a repeat of the 44% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Taiyo KisokogyoLtd 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. Taiyo KisokogyoLtd 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. Over the last three years, Taiyo KisokogyoLtd reported free cash flow worth 6.4% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Taiyo KisokogyoLtd has JP¥1.94b in net cash and a decent-looking balance sheet. So we don't have any problem with Taiyo KisokogyoLtd's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Taiyo KisokogyoLtd has 2 warning signs we think you should be aware of.

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. 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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