Is Aiko (TYO:9909) A Risky Investment?

By
Simply Wall St
Published
April 05, 2021
Source: Shutterstock

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. Importantly, Aiko Corporation (TYO:9909) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.

View our latest analysis for Aiko

What Is Aiko's Net Debt?

The chart below, which you can click on for greater detail, shows that Aiko had JP¥1.80b in debt in December 2020; about the same as the year before. However, it does have JP¥2.40b in cash offsetting this, leading to net cash of JP¥597.0m.

debt-equity-history-analysis
JASDAQ:9909 Debt to Equity History April 6th 2021

How Healthy Is Aiko's Balance Sheet?

We can see from the most recent balance sheet that Aiko had liabilities of JP¥3.39b falling due within a year, and liabilities of JP¥241.0m due beyond that. Offsetting this, it had JP¥2.40b in cash and JP¥2.53b in receivables that were due within 12 months. So it actually has JP¥1.29b more liquid assets than total liabilities.

This luscious liquidity implies that Aiko's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Aiko has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Aiko's load is not too heavy, because its EBIT was down 82% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Aiko'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Aiko 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. During the last three years, Aiko generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Aiko has JP¥597.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥289m, being 86% of its EBIT. So we don't think Aiko's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Aiko you should be aware of, and 1 of them is significant.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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