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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Super Tool Co. Ltd. (TYO:5990) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Super Tool
What Is Super Tool's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Super Tool had JP¥1.38b of debt, an increase on JP¥703.0m, over one year. However, it does have JP¥1.63b in cash offsetting this, leading to net cash of JP¥246.0m.
A Look At Super Tool's Liabilities
We can see from the most recent balance sheet that Super Tool had liabilities of JP¥2.31b falling due within a year, and liabilities of JP¥1.81b due beyond that. Offsetting this, it had JP¥1.63b in cash and JP¥1.33b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.17b.
While this might seem like a lot, it is not so bad since Super Tool has a market capitalization of JP¥4.54b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Super Tool boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Super Tool's load is not too heavy, because its EBIT was down 43% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Super Tool's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Super Tool 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. During the last three years, Super Tool burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing up
Although Super Tool's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥246.0m. So while Super Tool does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Super Tool that you should be aware of.
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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About TSE:5990
Super Tool
Manufactures and sells hand tools and industrial equipment tools in Japan and internationally.
Excellent balance sheet with proven track record.
