Stock Analysis

Is Terasaki ElectricLtd (TYO:6637) A Risky Investment?

TSE:6637
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Terasaki Electric Co.,Ltd. (TYO:6637) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Terasaki ElectricLtd

How Much Debt Does Terasaki ElectricLtd Carry?

The image below, which you can click on for greater detail, shows that Terasaki ElectricLtd had debt of JP¥2.40b at the end of September 2020, a reduction from JP¥3.01b over a year. But on the other hand it also has JP¥12.6b in cash, leading to a JP¥10.2b net cash position.

debt-equity-history-analysis
JASDAQ:6637 Debt to Equity History January 13th 2021

How Strong Is Terasaki ElectricLtd's Balance Sheet?

We can see from the most recent balance sheet that Terasaki ElectricLtd had liabilities of JP¥10.9b falling due within a year, and liabilities of JP¥3.14b due beyond that. Offsetting this, it had JP¥12.6b in cash and JP¥9.98b in receivables that were due within 12 months. So it can boast JP¥8.57b more liquid assets than total liabilities.

This surplus liquidity suggests that Terasaki ElectricLtd's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Terasaki ElectricLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Terasaki ElectricLtd has boosted its EBIT by 32%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Terasaki ElectricLtd'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. While Terasaki ElectricLtd 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 most recent three years, Terasaki ElectricLtd recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Terasaki ElectricLtd has net cash of JP¥10.2b, as well as more liquid assets than liabilities. And we liked the look of last year's 32% year-on-year EBIT growth. At the end of the day we're not concerned about Terasaki ElectricLtd's debt. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Terasaki ElectricLtd you should know about.

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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