Is Kumagai GumiLtd (TSE:1861) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Kumagai Gumi Co.,Ltd. (TSE:1861) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Kumagai GumiLtd

How Much Debt Does Kumagai GumiLtd Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Kumagai GumiLtd had debt of JP¥42.3b, up from JP¥22.1b in one year. But on the other hand it also has JP¥57.8b in cash, leading to a JP¥15.5b net cash position.

How Healthy Is Kumagai GumiLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kumagai GumiLtd had liabilities of JP¥217.4b due within 12 months and liabilities of JP¥43.8b due beyond that. On the other hand, it had cash of JP¥57.8b and JP¥266.6b worth of receivables due within a year. So it can boast JP¥63.3b more liquid assets than total liabilities.

This excess liquidity is a great indication that Kumagai GumiLtd's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Kumagai GumiLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Kumagai GumiLtd grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Kumagai GumiLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Kumagai GumiLtd 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, Kumagai GumiLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Kumagai GumiLtd has JP¥15.5b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 11% over the last year. So we don't think Kumagai GumiLtd'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. For instance, we've identified 1 warning sign for Kumagai GumiLtd that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.