Health Check: How Prudently Does Create (TYO:3024) Use Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Create Corporation (TYO:3024) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Create

What Is Create's Net Debt?

The image below, which you can click on for greater detail, shows that Create had debt of JP¥3.42b at the end of September 2020, a reduction from JP¥3.61b over a year. However, because it has a cash reserve of JP¥1.16b, its net debt is less, at about JP¥2.26b.

A Look At Create's Liabilities

Zooming in on the latest balance sheet data, we can see that Create had liabilities of JP¥9.33b due within 12 months and liabilities of JP¥2.41b due beyond that. Offsetting this, it had JP¥1.16b in cash and JP¥7.62b in receivables that were due within 12 months. So it has liabilities totalling JP¥2.96b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's JP¥2.45b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Create 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.

In the last year Create had a loss before interest and tax, and actually shrunk its revenue by 6.8%, to JP¥30b. That's not what we would hope to see.

Caveat Emptor

Importantly, Create had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at JP¥19m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of JP¥523m and the profit of JP¥25m. So there is definitely a chance that it can improve things in the next few years. 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. We've identified 3 warning signs with Create (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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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