These 4 Measures Indicate That Shoei YakuhinLtd (TYO:3537) Is Using Debt Reasonably Well

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. We can see that Shoei Yakuhin Co.,Ltd. (TYO:3537) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shoei YakuhinLtd

What Is Shoei YakuhinLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Shoei YakuhinLtd had JP¥648.0m of debt, an increase on JP¥547.0m, over one year. However, it does have JP¥1.78b in cash offsetting this, leading to net cash of JP¥1.13b.

How Healthy Is Shoei YakuhinLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shoei YakuhinLtd had liabilities of JP¥5.51b due within 12 months and liabilities of JP¥1.99b due beyond that. On the other hand, it had cash of JP¥1.78b and JP¥5.74b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Shoei YakuhinLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the JP¥3.52b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Shoei YakuhinLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Shoei YakuhinLtd's EBIT dived 17%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shoei YakuhinLtd 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. Shoei YakuhinLtd 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. In the last three years, Shoei YakuhinLtd's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Shoei YakuhinLtd has JP¥1.13b in net cash and a decent-looking balance sheet. So we don't have any problem with Shoei YakuhinLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Shoei YakuhinLtd is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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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