Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Masaru Corporation (TYO:1795) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
See our latest analysis for Masaru
What Is Masaru's Net Debt?
The image below, which you can click on for greater detail, shows that Masaru had debt of JP¥612.0m at the end of September 2020, a reduction from JP¥742.0m over a year. However, it does have JP¥2.39b in cash offsetting this, leading to net cash of JP¥1.77b.
How Healthy Is Masaru's Balance Sheet?
The latest balance sheet data shows that Masaru had liabilities of JP¥3.23b due within a year, and liabilities of JP¥252.0m falling due after that. Offsetting this, it had JP¥2.39b in cash and JP¥1.73b in receivables that were due within 12 months. So it actually has JP¥636.0m more liquid assets than total liabilities.
This surplus suggests that Masaru is using debt in a way that is appears to be both safe and conservative. 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 Masaru has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Masaru has boosted its EBIT by 45%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Masaru 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. Masaru 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, Masaru actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
While it is always sensible to investigate a company's debt, in this case Masaru has JP¥1.77b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 118% of that EBIT to free cash flow, bringing in JP¥1.2b. When it comes to Masaru's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. For instance, we've identified 3 warning signs for Masaru that 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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About TSE:1795
Excellent balance sheet average dividend payer.
