Sugita AceLtd (TYO:7635) Could Easily Take On More Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Sugita Ace Co.,Ltd. (TYO:7635) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sugita AceLtd

How Much Debt Does Sugita AceLtd Carry?

The image below, which you can click on for greater detail, shows that Sugita AceLtd had debt of JP¥1.90b at the end of December 2020, a reduction from JP¥2.02b over a year. However, its balance sheet shows it holds JP¥2.83b in cash, so it actually has JP¥937.0m net cash.

A Look At Sugita AceLtd's Liabilities

We can see from the most recent balance sheet that Sugita AceLtd had liabilities of JP¥16.5b falling due within a year, and liabilities of JP¥2.60b due beyond that. On the other hand, it had cash of JP¥2.83b and JP¥14.6b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.67b.

Sugita AceLtd has a market capitalization of JP¥5.32b, so it could very likely raise cash to ameliorate 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.

Also positive, Sugita AceLtd grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. 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 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. 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 90% 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

While Sugita AceLtd does have more liabilities than liquid assets, it also has net cash of JP¥937.0m. And it impressed us with free cash flow of JP¥296m, being 90% of its EBIT. So we don't think Sugita AceLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Sugita AceLtd (including 1 which is a bit unpleasant) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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