Here's Why Koken Boring MachineLtd (TYO:6297) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Koken Boring Machine Co.,Ltd. (TYO:6297) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Koken Boring MachineLtd

What Is Koken Boring MachineLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Koken Boring MachineLtd had JP¥1.45b of debt, an increase on JP¥1.08b, over one year. But on the other hand it also has JP¥2.27b in cash, leading to a JP¥814.0m net cash position.

How Strong Is Koken Boring MachineLtd's Balance Sheet?

We can see from the most recent balance sheet that Koken Boring MachineLtd had liabilities of JP¥3.95b falling due within a year, and liabilities of JP¥1.22b due beyond that. Offsetting this, it had JP¥2.27b in cash and JP¥2.17b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥728.0m.

Given Koken Boring MachineLtd has a market capitalization of JP¥4.98b, 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. While it does have liabilities worth noting, Koken Boring MachineLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Koken Boring MachineLtd saw its EBIT decline by 8.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is Koken Boring MachineLtd's earnings that will influence how the balance sheet holds up in the future. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Koken Boring MachineLtd 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 last three years, Koken Boring MachineLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

Although Koken Boring MachineLtd'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¥814.0m. So while Koken Boring MachineLtd does not have a great balance sheet, it's certainly not too bad. 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. We've identified 3 warning signs with Koken Boring MachineLtd , and understanding them should be part of your investment process.

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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