Is Nippon Dry-Chemical (TSE:1909) Using Too Much Debt?

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.' 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. Importantly, Nippon Dry-Chemical Co., Ltd. (TSE:1909) does carry debt. But should shareholders be worried about its use of debt?

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What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Nippon Dry-Chemical's Debt?

The image below, which you can click on for greater detail, shows that Nippon Dry-Chemical had debt of JP¥5.72b at the end of December 2024, a reduction from JP¥8.87b over a year. But on the other hand it also has JP¥8.19b in cash, leading to a JP¥2.47b net cash position.

How Strong Is Nippon Dry-Chemical's Balance Sheet?

The latest balance sheet data shows that Nippon Dry-Chemical had liabilities of JP¥14.8b due within a year, and liabilities of JP¥4.21b falling due after that. Offsetting these obligations, it had cash of JP¥8.19b as well as receivables valued at JP¥14.4b due within 12 months. So it can boast JP¥3.58b more liquid assets than total liabilities.

This surplus suggests that Nippon Dry-Chemical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Nippon Dry-Chemical has more cash than debt is arguably a good indication that it can manage its debt safely.

See our latest analysis for Nippon Dry-Chemical

And we also note warmly that Nippon Dry-Chemical grew its EBIT by 17% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Nippon Dry-Chemical 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Nippon Dry-Chemical 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, Nippon Dry-Chemical's free cash flow amounted to 39% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nippon Dry-Chemical has net cash of JP¥2.47b, as well as more liquid assets than liabilities. And we liked the look of last year's 17% year-on-year EBIT growth. So is Nippon Dry-Chemical's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Nippon Dry-Chemical , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.