Is Kanda Tsushinki (TYO:1992) A Risky Investment?

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.' 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. We note that Kanda Tsushinki Co., Ltd. (TYO:1992) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.

Check out our latest analysis for Kanda Tsushinki

What Is Kanda Tsushinki's Debt?

The chart below, which you can click on for greater detail, shows that Kanda Tsushinki had JP¥190.0m in debt in September 2020; about the same as the year before. However, it does have JP¥2.23b in cash offsetting this, leading to net cash of JP¥2.04b.

How Strong Is Kanda Tsushinki's Balance Sheet?

The latest balance sheet data shows that Kanda Tsushinki had liabilities of JP¥1.83b due within a year, and liabilities of JP¥1.23b falling due after that. Offsetting this, it had JP¥2.23b in cash and JP¥1.08b in receivables that were due within 12 months. So it actually has JP¥252.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Kanda Tsushinki could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Kanda Tsushinki has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Kanda Tsushinki grew its EBIT by 101% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kanda Tsushinki 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Kanda Tsushinki 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, Kanda Tsushinki recorded free cash flow worth 75% 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 it is always sensible to investigate a company's debt, in this case Kanda Tsushinki has JP¥2.04b in net cash and a decent-looking balance sheet. And we liked the look of last year's 101% year-on-year EBIT growth. So is Kanda Tsushinki'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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Kanda Tsushinki you should know about.

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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