Is Harmonic Drive Systems (TYO:6324) Using Debt Sensibly?

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.' 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 Harmonic Drive Systems Inc. (TYO:6324) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Harmonic Drive Systems

How Much Debt Does Harmonic Drive Systems Carry?

The image below, which you can click on for greater detail, shows that Harmonic Drive Systems had debt of JP¥6.49b at the end of December 2020, a reduction from JP¥6.96b over a year. But on the other hand it also has JP¥22.9b in cash, leading to a JP¥16.4b net cash position.

How Healthy Is Harmonic Drive Systems' Balance Sheet?

According to the last reported balance sheet, Harmonic Drive Systems had liabilities of JP¥6.46b due within 12 months, and liabilities of JP¥21.5b due beyond 12 months. Offsetting these obligations, it had cash of JP¥22.9b as well as receivables valued at JP¥9.10b due within 12 months. So it actually has JP¥4.07b more liquid assets than total liabilities.

Having regard to Harmonic Drive Systems' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the JP¥748.9b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Harmonic Drive Systems has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Harmonic Drive Systems's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Harmonic Drive Systems had a loss before interest and tax, and actually shrunk its revenue by 23%, to JP¥35b. That makes us nervous, to say the least.

So How Risky Is Harmonic Drive Systems?

While Harmonic Drive Systems lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow JP¥5.8b. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Harmonic Drive Systems's profit, revenue, and operating cashflow have changed over the last few years.

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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