Is Dai-Dan (TSE:1980) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Dai-Dan Co., Ltd. (TSE:1980) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Dai-Dan

What Is Dai-Dan's Debt?

As you can see below, at the end of December 2023, Dai-Dan had JP¥10.2b of debt, up from JP¥3.60b a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥20.3b in cash, so it actually has JP¥10.0b net cash.

How Healthy Is Dai-Dan's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dai-Dan had liabilities of JP¥58.6b due within 12 months and liabilities of JP¥5.29b due beyond that. Offsetting these obligations, it had cash of JP¥20.3b as well as receivables valued at JP¥80.3b due within 12 months. So it actually has JP¥36.7b more liquid assets than total liabilities.

This excess liquidity suggests that Dai-Dan is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Dai-Dan has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Dai-Dan grew its EBIT at 10% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is Dai-Dan's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Dai-Dan may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Dai-Dan reported free cash flow worth 15% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Dai-Dan has JP¥10.0b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 10% over the last year. So is Dai-Dan'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. To that end, you should be aware of the 2 warning signs we've spotted with Dai-Dan .

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.