Tokuden (TYO:3437) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Tokuden Co., Ltd. (TYO:3437) does carry debt. But is this debt a concern to shareholders?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Tokuden

What Is Tokuden's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Tokuden had JP¥180.0m of debt, an increase on JP¥60.0m, over one year. However, it does have JP¥2.48b in cash offsetting this, leading to net cash of JP¥2.30b.

How Strong Is Tokuden's Balance Sheet?

According to the last reported balance sheet, Tokuden had liabilities of JP¥2.17b due within 12 months, and liabilities of JP¥766.0m due beyond 12 months. Offsetting this, it had JP¥2.48b in cash and JP¥3.21b in receivables that were due within 12 months. So it can boast JP¥2.75b more liquid assets than total liabilities.

This excess liquidity is a great indication that Tokuden's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Tokuden has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Tokuden if management cannot prevent a repeat of the 46% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tokuden'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tokuden 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. In the last three years, Tokuden's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tokuden has net cash of JP¥2.30b, as well as more liquid assets than liabilities. So we don't think Tokuden's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Tokuden .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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