Here's Why Nippon Pallet Pool (TSE:4690) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Nippon Pallet Pool Co., Ltd. (TSE:4690) makes use of debt. But should shareholders be worried about its use of debt?

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Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

What Is Nippon Pallet Pool's Debt?

The image below, which you can click on for greater detail, shows that Nippon Pallet Pool had debt of JP¥2.41b at the end of December 2024, a reduction from JP¥3.14b over a year. On the flip side, it has JP¥1.48b in cash leading to net debt of about JP¥936.2m.

How Strong Is Nippon Pallet Pool's Balance Sheet?

We can see from the most recent balance sheet that Nippon Pallet Pool had liabilities of JP¥2.64b falling due within a year, and liabilities of JP¥1.20b due beyond that. Offsetting these obligations, it had cash of JP¥1.48b as well as receivables valued at JP¥895.6m due within 12 months. So its liabilities total JP¥1.47b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Nippon Pallet Pool is worth JP¥2.84b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

See our latest analysis for Nippon Pallet Pool

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Nippon Pallet Pool has a low net debt to EBITDA ratio of only 0.31. And its EBIT easily covers its interest expense, being 18.3 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Nippon Pallet Pool's saving grace is its low debt levels, because its EBIT has tanked 47% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nippon Pallet Pool 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Nippon Pallet Pool actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Nippon Pallet Pool's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Nippon Pallet Pool is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Case in point: We've spotted 3 warning signs for Nippon Pallet Pool you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.