Micron Machinery (TYO:6159) Seems To Use Debt Rather Sparingly

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.' 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 can see that Micron Machinery Co., Ltd. (TYO:6159) does use debt in its business. But is this debt a concern to shareholders?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Micron Machinery

What Is Micron Machinery's Net Debt?

The image below, which you can click on for greater detail, shows that at November 2020 Micron Machinery had debt of JP¥519.0m, up from JP¥486.0m in one year. However, it does have JP¥4.27b in cash offsetting this, leading to net cash of JP¥3.75b.

How Strong Is Micron Machinery's Balance Sheet?

According to the last reported balance sheet, Micron Machinery had liabilities of JP¥1.42b due within 12 months, and liabilities of JP¥220.0m due beyond 12 months. Offsetting this, it had JP¥4.27b in cash and JP¥1.21b in receivables that were due within 12 months. So it actually has JP¥3.84b more liquid assets than total liabilities.

This luscious liquidity implies that Micron Machinery's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Micron Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Micron Machinery's EBIT dived 16%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Micron Machinery will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Micron Machinery 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, Micron Machinery produced sturdy free cash flow equating to 69% 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 Micron Machinery has JP¥3.75b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥286m, being 69% of its EBIT. So is Micron Machinery's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Micron Machinery (including 1 which 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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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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