NISSO PRONITY (TSE:3440) Seems To Use Debt Quite Sensibly

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. As with many other companies NISSO PRONITY Co., Ltd. (TSE:3440) makes use of debt. But the more important question is: how much risk is that debt creating?

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When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is NISSO PRONITY's Net Debt?

As you can see below, at the end of November 2024, NISSO PRONITY had JP¥9.10b of debt, up from JP¥6.96b a year ago. Click the image for more detail. However, it does have JP¥6.65b in cash offsetting this, leading to net debt of about JP¥2.45b.

A Look At NISSO PRONITY's Liabilities

According to the last reported balance sheet, NISSO PRONITY had liabilities of JP¥9.50b due within 12 months, and liabilities of JP¥3.86b due beyond 12 months. Offsetting these obligations, it had cash of JP¥6.65b as well as receivables valued at JP¥6.86b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This short term liquidity is a sign that NISSO PRONITY could probably pay off its debt with ease, as its balance sheet is far from stretched.

View our latest analysis for NISSO PRONITY

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

NISSO PRONITY's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 30.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, NISSO PRONITY grew its EBIT by 158% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since NISSO PRONITY will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend .

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, NISSO PRONITY saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

NISSO PRONITY's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that NISSO PRONITY can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for NISSO PRONITY you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.