We Think NFK Holdings (TYO:6494) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that NFK Holdings Co., Ltd. (TYO:6494) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for NFK Holdings

How Much Debt Does NFK Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 NFK Holdings had JP¥260.0m of debt, an increase on JP¥98.0m, over one year. However, its balance sheet shows it holds JP¥1.84b in cash, so it actually has JP¥1.58b net cash.

How Healthy Is NFK Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NFK Holdings had liabilities of JP¥506.0m due within 12 months and liabilities of JP¥564.0m due beyond that. Offsetting this, it had JP¥1.84b in cash and JP¥798.0m in receivables that were due within 12 months. So it actually has JP¥1.57b more liquid assets than total liabilities.

This surplus liquidity suggests that NFK Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, NFK Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, NFK Holdings grew its EBIT by 58% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is NFK Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While NFK Holdings 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 two years, NFK Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case NFK Holdings has JP¥1.58b in net cash and a decent-looking balance sheet. And we liked the look of last year's 58% year-on-year EBIT growth. So we don't think NFK Holdings's use of debt is risky. 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, we've discovered 2 warning signs for NFK Holdings that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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