Is Nippon Hume (TSE:5262) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Nippon Hume Corporation (TSE:5262) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Nippon Hume

What Is Nippon Hume's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Nippon Hume had JP¥1.51b of debt, an increase on JP¥1.07b, over one year. But on the other hand it also has JP¥14.4b in cash, leading to a JP¥12.9b net cash position.

How Strong Is Nippon Hume's Balance Sheet?

The latest balance sheet data shows that Nippon Hume had liabilities of JP¥15.7b due within a year, and liabilities of JP¥4.83b falling due after that. On the other hand, it had cash of JP¥14.4b and JP¥13.4b worth of receivables due within a year. So it actually has JP¥7.27b more liquid assets than total liabilities.

This excess liquidity suggests that Nippon Hume is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Nippon Hume has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Nippon Hume grew its EBIT at 12% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nippon Hume'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Nippon Hume 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. During the last three years, Nippon Hume produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nippon Hume has net cash of JP¥12.9b, as well as more liquid assets than liabilities. So we don't think Nippon Hume's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Nippon Hume (of which 1 doesn't sit too well with us!) you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com