Is Kumagai GumiLtd (TSE:1861) Using Too Much Debt?

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.' 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.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kumagai GumiLtd

What Is Kumagai GumiLtd's Debt?

The image below, which you can click on for greater detail, shows that Kumagai GumiLtd had debt of JP¥39.1b at the end of September 2024, a reduction from JP¥41.2b over a year. But on the other hand it also has JP¥46.6b in cash, leading to a JP¥7.50b net cash position.

How Strong Is Kumagai GumiLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kumagai GumiLtd had liabilities of JP¥202.6b due within 12 months and liabilities of JP¥45.6b due beyond that. Offsetting these obligations, it had cash of JP¥46.6b as well as receivables valued at JP¥260.0b due within 12 months. So it can boast JP¥58.5b more liquid assets than total liabilities.

This surplus liquidity suggests that Kumagai GumiLtd'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. Succinctly put, Kumagai GumiLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Kumagai GumiLtd has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Considering the last three years, Kumagai GumiLtd actually recorded a cash outflow, overall. 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 we empathize with investors who find debt concerning, you should keep in mind that Kumagai GumiLtd has net cash of JP¥7.50b, as well as more liquid assets than liabilities. So we are not troubled with Kumagai GumiLtd's debt use. 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. Be aware that Kumagai GumiLtd is showing 1 warning sign in our investment analysis , you should know about...

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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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.