Takasago Thermal Engineering (TSE:1969) Seems To Use Debt Rather Sparingly

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. We can see that Takasago Thermal Engineering Co., Ltd. (TSE:1969) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Takasago Thermal Engineering

What Is Takasago Thermal Engineering's Net Debt?

The image below, which you can click on for greater detail, shows that Takasago Thermal Engineering had debt of JP¥22.2b at the end of June 2024, a reduction from JP¥29.7b over a year. However, it does have JP¥41.2b in cash offsetting this, leading to net cash of JP¥19.0b.

How Strong Is Takasago Thermal Engineering's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Takasago Thermal Engineering had liabilities of JP¥99.3b due within 12 months and liabilities of JP¥25.7b due beyond that. On the other hand, it had cash of JP¥41.2b and JP¥143.0b worth of receivables due within a year. So it can boast JP¥59.3b more liquid assets than total liabilities.

This surplus suggests that Takasago Thermal Engineering is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Takasago Thermal Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Takasago Thermal Engineering has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Takasago Thermal Engineering's ability to maintain a healthy balance sheet going forward. 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 Takasago Thermal Engineering 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. Looking at the most recent three years, Takasago Thermal Engineering recorded free cash flow of 39% of its EBIT, which is weaker 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 Takasago Thermal Engineering has JP¥19.0b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 33% over the last year. So we don't think Takasago Thermal Engineering's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Takasago Thermal Engineering .

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.