These 4 Measures Indicate That Tohoku Chemical (TYO:7446) Is Using Debt Reasonably Well

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Tohoku Chemical Co., Ltd. (TYO:7446) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tohoku Chemical

What Is Tohoku Chemical's Debt?

You can click the graphic below for the historical numbers, but it shows that Tohoku Chemical had JP¥237.0m of debt in September 2020, down from JP¥597.0m, one year before. But it also has JP¥769.0m in cash to offset that, meaning it has JP¥532.0m net cash.

How Strong Is Tohoku Chemical's Balance Sheet?

According to the last reported balance sheet, Tohoku Chemical had liabilities of JP¥7.96b due within 12 months, and liabilities of JP¥977.0m due beyond 12 months. Offsetting this, it had JP¥769.0m in cash and JP¥7.76b in receivables that were due within 12 months. So its liabilities total JP¥407.0m more than the combination of its cash and short-term receivables.

Of course, Tohoku Chemical has a market capitalization of JP¥2.89b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Tohoku Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Tohoku Chemical grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Tohoku Chemical'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Tohoku Chemical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Tohoku Chemical 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

Although Tohoku Chemical's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥532.0m. And we liked the look of last year's 28% year-on-year EBIT growth. So we don't have any problem with Tohoku Chemical's use of 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. Take risks, for example - Tohoku Chemical has 3 warning signs we think you should be aware of.

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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