Is Nakano RefrigeratorsLtd (TYO:6411) Using Too Much Debt?

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 note that Nakano Refrigerators Co.,Ltd. (TYO:6411) does have debt on its balance sheet. 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. 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. 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 Nakano RefrigeratorsLtd

How Much Debt Does Nakano RefrigeratorsLtd Carry?

The chart below, which you can click on for greater detail, shows that Nakano RefrigeratorsLtd had JP¥250.0m in debt in September 2020; about the same as the year before. But on the other hand it also has JP¥17.4b in cash, leading to a JP¥17.1b net cash position.

A Look At Nakano RefrigeratorsLtd's Liabilities

According to the last reported balance sheet, Nakano RefrigeratorsLtd had liabilities of JP¥3.95b due within 12 months, and liabilities of JP¥3.54b due beyond 12 months. Offsetting this, it had JP¥17.4b in cash and JP¥4.17b in receivables that were due within 12 months. So it actually has JP¥14.1b more liquid assets than total liabilities.

This excess liquidity is a great indication that Nakano RefrigeratorsLtd's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Nakano RefrigeratorsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Nakano RefrigeratorsLtd's load is not too heavy, because its EBIT was down 59% 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 Nakano RefrigeratorsLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. While Nakano RefrigeratorsLtd 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, Nakano RefrigeratorsLtd 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

While we empathize with investors who find debt concerning, you should keep in mind that Nakano RefrigeratorsLtd has net cash of JP¥17.1b, as well as more liquid assets than liabilities. So we don't have any problem with Nakano RefrigeratorsLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Nakano RefrigeratorsLtd (1 can't be ignored) you should be aware of.

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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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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