These 4 Measures Indicate That Nippon Pallet Pool (TSE:4690) Is Using Debt Extensively

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.' 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 Nippon Pallet Pool Co., Ltd. (TSE:4690) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Nippon Pallet Pool

What Is Nippon Pallet Pool's Debt?

You can click the graphic below for the historical numbers, but it shows that Nippon Pallet Pool had JP¥2.92b of debt in March 2024, down from JP¥3.55b, one year before. However, it does have JP¥1.61b in cash offsetting this, leading to net debt of about JP¥1.31b.

A Look At Nippon Pallet Pool's Liabilities

According to the last reported balance sheet, Nippon Pallet Pool had liabilities of JP¥3.10b due within 12 months, and liabilities of JP¥1.77b due beyond 12 months. Offsetting this, it had JP¥1.61b in cash and JP¥991.0m in receivables that were due within 12 months. So its liabilities total JP¥2.26b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of JP¥3.40b, so it does suggest shareholders should keep an eye on Nippon Pallet Pool's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Nippon Pallet Pool has a low net debt to EBITDA ratio of only 0.41. And its EBIT covers its interest expense a whopping 27.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that Nippon Pallet Pool's load is not too heavy, because its EBIT was down 21% over the last year. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Nippon Pallet Pool recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

We feel some trepidation about Nippon Pallet Pool's difficulty EBIT growth rate, but we've got positives to focus on, too. To wit both its interest cover and net debt to EBITDA were encouraging signs. We think that Nippon Pallet Pool's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Nippon Pallet Pool , and understanding them should be part of your investment process.

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.

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