Does Sugita AceLtd (TYO:7635) Have A Healthy 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Sugita Ace Co.,Ltd. (TYO:7635) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. 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 Sugita AceLtd

What Is Sugita AceLtd's Debt?

The image below, which you can click on for greater detail, shows that Sugita AceLtd had debt of JP¥1.70b at the end of September 2020, a reduction from JP¥2.15b over a year. However, its balance sheet shows it holds JP¥2.62b in cash, so it actually has JP¥926.0m net cash.

How Strong Is Sugita AceLtd's Balance Sheet?

We can see from the most recent balance sheet that Sugita AceLtd had liabilities of JP¥15.3b falling due within a year, and liabilities of JP¥2.44b due beyond that. Offsetting this, it had JP¥2.62b in cash and JP¥13.2b in receivables that were due within 12 months. So its liabilities total JP¥1.92b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Sugita AceLtd is worth JP¥5.23b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Sugita AceLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Sugita AceLtd grew its EBIT by 6.8% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sugita AceLtd will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sugita AceLtd 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 last three years, Sugita AceLtd recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

Although Sugita AceLtd'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¥926.0m. And it impressed us with free cash flow of JP¥296m, being 92% of its EBIT. So is Sugita AceLtd's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 2 warning signs for Sugita AceLtd (1 is concerning) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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