Iwabuchi (TYO:5983) Has A Rock Solid Balance Sheet

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 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 Iwabuchi Corporation (TYO:5983) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Iwabuchi

What Is Iwabuchi's Net Debt?

As you can see below, Iwabuchi had JP¥416.0m of debt at December 2020, down from JP¥529.0m a year prior. But on the other hand it also has JP¥6.91b in cash, leading to a JP¥6.49b net cash position.

How Healthy Is Iwabuchi's Balance Sheet?

We can see from the most recent balance sheet that Iwabuchi had liabilities of JP¥2.28b falling due within a year, and liabilities of JP¥1.30b due beyond that. On the other hand, it had cash of JP¥6.91b and JP¥3.18b worth of receivables due within a year. So it actually has JP¥6.52b more liquid assets than total liabilities.

This luscious liquidity implies that Iwabuchi's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Iwabuchi has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Iwabuchi has increased its EBIT by 2.9% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Iwabuchi 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Iwabuchi 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. Happily for any shareholders, Iwabuchi actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, the bottom line is that Iwabuchi has net cash of JP¥6.49b and plenty of liquid assets. And it impressed us with free cash flow of JP¥476m, being 159% of its EBIT. When it comes to Iwabuchi's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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 Iwabuchi is showing 4 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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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