Kokusai (TYO:7722) Seems To Use Debt Rather Sparingly

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. As with many other companies Kokusai Co., Ltd. (TYO:7722) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Kokusai

What Is Kokusai's Debt?

As you can see below, Kokusai had JP¥1.18b of debt at September 2020, down from JP¥1.53b a year prior. But it also has JP¥5.01b in cash to offset that, meaning it has JP¥3.84b net cash.

How Healthy Is Kokusai's Balance Sheet?

We can see from the most recent balance sheet that Kokusai had liabilities of JP¥5.74b falling due within a year, and liabilities of JP¥719.0m due beyond that. Offsetting this, it had JP¥5.01b in cash and JP¥2.75b in receivables that were due within 12 months. So it actually has JP¥1.30b more liquid assets than total liabilities.

This surplus suggests that Kokusai has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Kokusai boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Kokusai grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Kokusai's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Kokusai 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, Kokusai recorded free cash flow worth 58% 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 Kokusai has net cash of JP¥3.84b, as well as more liquid assets than liabilities. And we liked the look of last year's 34% year-on-year EBIT growth. So we don't think Kokusai'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. For instance, we've identified 2 warning signs for Kokusai that you should be aware of.

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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