Is MonotaRO (TSE:3064) 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that MonotaRO Co., Ltd. (TSE:3064) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 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 MonotaRO

What Is MonotaRO's Debt?

The image below, which you can click on for greater detail, shows that MonotaRO had debt of JP¥2.93b at the end of March 2024, a reduction from JP¥7.48b over a year. However, its balance sheet shows it holds JP¥14.6b in cash, so it actually has JP¥11.6b net cash.

How Healthy Is MonotaRO's Balance Sheet?

The latest balance sheet data shows that MonotaRO had liabilities of JP¥33.5b due within a year, and liabilities of JP¥4.44b falling due after that. Offsetting this, it had JP¥14.6b in cash and JP¥39.9b in receivables that were due within 12 months. So it can boast JP¥16.4b more liquid assets than total liabilities.

This short term liquidity is a sign that MonotaRO could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that MonotaRO has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that MonotaRO grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MonotaRO's ability to maintain a healthy balance sheet going forward. 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 MonotaRO 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, MonotaRO recorded free cash flow of 40% of its EBIT, which is weaker 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 MonotaRO has net cash of JP¥11.6b, 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 MonotaRO's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for MonotaRO that you should be aware of.

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.