Is Kyoritsu Air Tech (TYO:5997) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Kyoritsu Air Tech Inc. (TYO:5997) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Kyoritsu Air Tech

How Much Debt Does Kyoritsu Air Tech Carry?

As you can see below, Kyoritsu Air Tech had JP¥1.70b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have JP¥3.12b in cash offsetting this, leading to net cash of JP¥1.42b.

A Look At Kyoritsu Air Tech's Liabilities

We can see from the most recent balance sheet that Kyoritsu Air Tech had liabilities of JP¥4.06b falling due within a year, and liabilities of JP¥858.0m due beyond that. Offsetting these obligations, it had cash of JP¥3.12b as well as receivables valued at JP¥2.96b due within 12 months. So it can boast JP¥1.16b more liquid assets than total liabilities.

This luscious liquidity implies that Kyoritsu Air Tech's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, Kyoritsu Air Tech boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Kyoritsu Air Tech's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kyoritsu Air Tech'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Kyoritsu Air Tech 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. During the last three years, Kyoritsu Air Tech produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Kyoritsu Air Tech has JP¥1.42b in net cash and a decent-looking balance sheet. So is Kyoritsu Air Tech's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Kyoritsu Air Tech that you should be aware of before investing here.

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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