Is ETS HoldingsLtd (TYO:1789) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 ETS Holdings Co.,Ltd. (TYO:1789) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for ETS HoldingsLtd

How Much Debt Does ETS HoldingsLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2020 ETS HoldingsLtd had debt of JP¥649.0m, up from JP¥300.0m in one year. However, it does have JP¥2.63b in cash offsetting this, leading to net cash of JP¥1.98b.

How Healthy Is ETS HoldingsLtd's Balance Sheet?

The latest balance sheet data shows that ETS HoldingsLtd had liabilities of JP¥1.71b due within a year, and liabilities of JP¥426.0m falling due after that. Offsetting these obligations, it had cash of JP¥2.63b as well as receivables valued at JP¥1.08b due within 12 months. So it can boast JP¥1.57b more liquid assets than total liabilities.

It's good to see that ETS HoldingsLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that ETS HoldingsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that ETS HoldingsLtd saw its EBIT decline by 7.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is ETS HoldingsLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ETS HoldingsLtd 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 most recent three years, ETS HoldingsLtd recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that ETS HoldingsLtd has net cash of JP¥1.98b, as well as more liquid assets than liabilities. So is ETS HoldingsLtd's debt a risk? It doesn't seem so to us. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for ETS HoldingsLtd (of which 1 is potentially serious!) you should know about.

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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