These 4 Measures Indicate That Odawara Engineering (TYO:6149) Is Using Debt Reasonably Well

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Odawara Engineering Co., Ltd. (TYO:6149) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Odawara Engineering

What Is Odawara Engineering's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Odawara Engineering had debt of JP¥3.05b, up from none in one year. But it also has JP¥4.27b in cash to offset that, meaning it has JP¥1.23b net cash.

A Look At Odawara Engineering's Liabilities

Zooming in on the latest balance sheet data, we can see that Odawara Engineering had liabilities of JP¥7.97b due within 12 months and liabilities of JP¥405.0m due beyond that. On the other hand, it had cash of JP¥4.27b and JP¥2.92b worth of receivables due within a year. So it has liabilities totalling JP¥1.18b more than its cash and near-term receivables, combined.

Given Odawara Engineering has a market capitalization of JP¥20.2b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Odawara Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Odawara Engineering grew its EBIT by 71% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Odawara Engineering can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Odawara Engineering 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, Odawara Engineering burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

We could understand if investors are concerned about Odawara Engineering's liabilities, but we can be reassured by the fact it has has net cash of JP¥1.23b. And it impressed us with its EBIT growth of 71% over the last year. So we don't have any problem with Odawara Engineering's use of debt. 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. Be aware that Odawara Engineering is showing 1 warning sign in our investment analysis , 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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