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.' 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. We can see that Moriya Corporation (TYO:1798) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Moriya
What Is Moriya's Net Debt?
As you can see below, at the end of September 2020, Moriya had JP¥3.20b of debt, up from JP¥1.60b a year ago. Click the image for more detail. But it also has JP¥6.42b in cash to offset that, meaning it has JP¥3.22b net cash.
A Look At Moriya's Liabilities
Zooming in on the latest balance sheet data, we can see that Moriya had liabilities of JP¥15.1b due within 12 months and liabilities of JP¥1.39b due beyond that. Offsetting these obligations, it had cash of JP¥6.42b as well as receivables valued at JP¥9.80b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Since publicly traded Moriya shares are worth a total of JP¥4.38b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Moriya boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that Moriya has increased its EBIT by 4.4% 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 it is Moriya's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Moriya 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. During the last three years, Moriya 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 look at a company's total liabilities, it is very reassuring that Moriya has JP¥3.22b in net cash. On top of that, it increased its EBIT by 4.4% in the last twelve months. So we are not troubled with Moriya's debt use. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Moriya (at least 2 which are potentially serious) , and understanding them should be part of your investment process.
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:1798
Excellent balance sheet average dividend payer.
