Is Chiyoda Ute (TYO:5387) Weighed On By Its Debt Load?

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. Importantly, Chiyoda Ute Co., Ltd. (TYO:5387) does carry debt. But the more important question is: how much risk is that debt creating?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Chiyoda Ute

How Much Debt Does Chiyoda Ute Carry?

You can click the graphic below for the historical numbers, but it shows that Chiyoda Ute had JP¥9.76b of debt in September 2020, down from JP¥11.6b, one year before. However, it does have JP¥2.95b in cash offsetting this, leading to net debt of about JP¥6.81b.

A Look At Chiyoda Ute's Liabilities

According to the last reported balance sheet, Chiyoda Ute had liabilities of JP¥8.50b due within 12 months, and liabilities of JP¥9.92b due beyond 12 months. On the other hand, it had cash of JP¥2.95b and JP¥4.24b worth of receivables due within a year. So its liabilities total JP¥11.2b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of JP¥9.28b, we think shareholders really should watch Chiyoda Ute's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chiyoda Ute will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Chiyoda Ute had a loss before interest and tax, and actually shrunk its revenue by 11%, to JP¥27b. We would much prefer see growth.

Caveat Emptor

While Chiyoda Ute's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at JP¥155m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of JP¥1.8b didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for Chiyoda Ute (of which 2 make us uncomfortable!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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