These 4 Measures Indicate That Nansin (TYO:7399) Is Using Debt Safely

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.' 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 Nansin Co., Ltd. (TYO:7399) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Nansin

What Is Nansin's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Nansin had JP¥1.92b of debt, an increase on JP¥500.0m, over one year. But on the other hand it also has JP¥5.19b in cash, leading to a JP¥3.27b net cash position.

How Strong Is Nansin's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Nansin had liabilities of JP¥3.37b due within 12 months and liabilities of JP¥1.24b due beyond that. Offsetting this, it had JP¥5.19b in cash and JP¥2.16b in receivables that were due within 12 months. So it can boast JP¥2.74b more liquid assets than total liabilities.

This surplus liquidity suggests that Nansin's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Nansin boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Nansin's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nansin'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 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 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Nansin has JP¥3.27b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥386m, being 72% of its EBIT. So we don't think Nansin's use of debt is risky. 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. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Nansin (of which 1 is a bit unpleasant!) you should know about.

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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