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. Importantly, Seiko Corporation (TYO:6286) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
View our latest analysis for Seiko
What Is Seiko's Net Debt?
As you can see below, at the end of September 2020, Seiko had JP¥3.19b of debt, up from JP¥2.13b a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥5.21b in cash, so it actually has JP¥2.03b net cash.
How Strong Is Seiko's Balance Sheet?
The latest balance sheet data shows that Seiko had liabilities of JP¥7.42b due within a year, and liabilities of JP¥1.88b falling due after that. Offsetting these obligations, it had cash of JP¥5.21b as well as receivables valued at JP¥2.90b due within 12 months. So its liabilities total JP¥1.18b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Seiko has a market capitalization of JP¥3.94b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Seiko also has more cash than debt, so we're pretty confident it can manage its debt safely.
The modesty of its debt load may become crucial for Seiko if management cannot prevent a repeat of the 25% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Seiko 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Seiko 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. Over the last three years, Seiko reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Summing up
Although Seiko'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¥2.03b. So although we see some areas for improvement, we're not too worried about Seiko's balance sheet. 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. For example - Seiko has 2 warning signs we think you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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:6286
Seiko
Engages in the manufacture, sale, repair, and remodeling of packaging machines and cold forged parts in Japan.
Solid track record with excellent balance sheet and pays a dividend.
