Is SantoLtd (TYO:1788) Using Too Much Debt?

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 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. We note that Santo Co.,Ltd. (TYO:1788) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for SantoLtd

How Much Debt Does SantoLtd Carry?

As you can see below, at the end of September 2020, SantoLtd had JP¥198.0m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥1.11b in cash, so it actually has JP¥911.0m net cash.

How Strong Is SantoLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SantoLtd had liabilities of JP¥1.39b due within 12 months and liabilities of JP¥57.0m due beyond that. Offsetting this, it had JP¥1.11b in cash and JP¥1.54b in receivables that were due within 12 months. So it actually has JP¥1.21b more liquid assets than total liabilities.

This surplus strongly suggests that SantoLtd has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that SantoLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact SantoLtd's saving grace is its low debt levels, because its EBIT has tanked 38% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is SantoLtd's earnings that will influence how the balance sheet holds up in the future. 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. SantoLtd 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. During the last three years, SantoLtd 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.

Summing up

While it is always sensible to investigate a company's debt, in this case SantoLtd has JP¥911.0m in net cash and a decent-looking balance sheet. So we don't have any problem with SantoLtd's use of debt. 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. Case in point: We've spotted 3 warning signs for SantoLtd you should be aware of, and 1 of them shouldn't be ignored.

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. 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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