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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Masaru Corporation (TSE:1795) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Masaru
What Is Masaru's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Masaru had JP¥376.0m of debt in March 2024, down from JP¥454.0m, one year before. However, its balance sheet shows it holds JP¥1.93b in cash, so it actually has JP¥1.55b net cash.
How Healthy Is Masaru's Balance Sheet?
We can see from the most recent balance sheet that Masaru had liabilities of JP¥2.34b falling due within a year, and liabilities of JP¥181.0m due beyond that. Offsetting this, it had JP¥1.93b in cash and JP¥2.03b in receivables that were due within 12 months. So it can boast JP¥1.44b more liquid assets than total liabilities.
This surplus liquidity suggests that Masaru's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Masaru has more cash than debt is arguably a good indication that it can manage its debt safely.
Even more impressive was the fact that Masaru grew its EBIT by 205% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Masaru's earnings that will influence how the balance sheet holds up in the future. 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Masaru 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. In the last three years, Masaru's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While it is always sensible to investigate a company's debt, in this case Masaru has JP¥1.55b in net cash and a decent-looking balance sheet. And we liked the look of last year's 205% year-on-year EBIT growth. So we don't think Masaru's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Masaru (of which 1 is a bit unpleasant!) you should know about.
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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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About TSE:1795
Proven track record with adequate balance sheet and pays a dividend.
