We Think ETS HoldingsLtd (TYO:1789) Can Manage Its Debt With Ease

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 ETS Holdings Co.,Ltd. (TYO:1789) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View 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 December 2020 ETS HoldingsLtd had debt of JP¥627.0m, up from JP¥300.0m in one year. However, it does have JP¥2.54b in cash offsetting this, leading to net cash of JP¥1.91b.

A Look At ETS HoldingsLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that ETS HoldingsLtd had liabilities of JP¥1.43b due within 12 months and liabilities of JP¥404.0m due beyond that. Offsetting these obligations, it had cash of JP¥2.54b as well as receivables valued at JP¥841.0m due within 12 months. So it can boast JP¥1.54b 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. Because it has plenty of assets, it is unlikely to have trouble 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.

While ETS HoldingsLtd doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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. While ETS HoldingsLtd 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 last three years, ETS HoldingsLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case ETS HoldingsLtd has JP¥1.91b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in JP¥75m. So we don't think ETS HoldingsLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for ETS HoldingsLtd that you should be aware of.

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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