Nansin (TYO:7399) Has A Rock Solid Balance Sheet

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.' 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 Nansin Co., Ltd. (TYO:7399) 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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Nansin

What Is Nansin's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Nansin had debt of JP¥1.92b, up from JP¥500.0m in one year. But it also has JP¥5.05b in cash to offset that, meaning it has JP¥3.13b net cash.

How Strong Is Nansin's Balance Sheet?

We can see from the most recent balance sheet that Nansin had liabilities of JP¥3.63b falling due within a year, and liabilities of JP¥1.22b due beyond that. Offsetting these obligations, it had cash of JP¥5.05b as well as receivables valued at JP¥2.70b due within 12 months. So it actually has JP¥2.90b more liquid assets than total liabilities.

This luscious liquidity implies that Nansin's balance sheet is sturdy like a giant sequoia tree. 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 Nansin has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Nansin grew its EBIT at 11% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Nansin will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Nansin 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, Nansin recorded free cash flow worth 76% 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 Nansin has net cash of JP¥3.13b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥386m, being 76% of its EBIT. When it comes to Nansin's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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 example Nansin has 3 warning signs (and 1 which is significant) we think 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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