These 4 Measures Indicate That Kyoritsu Air Tech (TYO:5997) Is Using Debt Safely

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Kyoritsu Air Tech Inc. (TYO:5997) makes use of debt. But is this debt a concern to shareholders?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Kyoritsu Air Tech

What Is Kyoritsu Air Tech's Net Debt?

As you can see below, Kyoritsu Air Tech had JP¥1.70b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has JP¥3.56b in cash, leading to a JP¥1.86b net cash position.

How Strong Is Kyoritsu Air Tech's Balance Sheet?

The latest balance sheet data shows that Kyoritsu Air Tech had liabilities of JP¥4.48b due within a year, and liabilities of JP¥828.0m falling due after that. Offsetting these obligations, it had cash of JP¥3.56b as well as receivables valued at JP¥3.07b due within 12 months. So it can boast JP¥1.32b more liquid assets than total liabilities.

This excess liquidity is a great indication that Kyoritsu Air Tech's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Kyoritsu Air Tech has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Kyoritsu Air Tech if management cannot prevent a repeat of the 36% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kyoritsu Air Tech 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Kyoritsu Air Tech 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. Over the most recent three years, Kyoritsu Air Tech recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kyoritsu Air Tech has net cash of JP¥1.86b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥538m, being 73% of its EBIT. So is Kyoritsu Air Tech's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 2 warning signs we've spotted with Kyoritsu Air Tech .

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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