We Think Fujita Engineering (TYO:1770) Can Manage Its Debt With Ease

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.' 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. Importantly, Fujita Engineering Co., Ltd. (TYO:1770) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, 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.

See our latest analysis for Fujita Engineering

How Much Debt Does Fujita Engineering Carry?

The image below, which you can click on for greater detail, shows that Fujita Engineering had debt of JP¥666.0m at the end of September 2020, a reduction from JP¥755.0m over a year. But it also has JP¥7.41b in cash to offset that, meaning it has JP¥6.75b net cash.

A Look At Fujita Engineering's Liabilities

Zooming in on the latest balance sheet data, we can see that Fujita Engineering had liabilities of JP¥5.96b due within 12 months and liabilities of JP¥1.40b due beyond that. Offsetting these obligations, it had cash of JP¥7.41b as well as receivables valued at JP¥6.00b due within 12 months. So it can boast JP¥6.05b more liquid assets than total liabilities.

This excess liquidity is a great indication that Fujita Engineering's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Fujita Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Fujita Engineering has increased its EBIT by 8.8% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fujita Engineering 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. While Fujita Engineering 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, Fujita Engineering 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 Fujita Engineering has net cash of JP¥6.75b, as well as more liquid assets than liabilities. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in JP¥1.6b. So is Fujita Engineering's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Fujita Engineering you should be aware of.

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. 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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