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. As with many other companies STG Co., Ltd. (TSE:5858) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is STG's Net Debt?
As you can see below, at the end of June 2025, STG had JP¥3.09b of debt, up from JP¥2.80b a year ago. Click the image for more detail. On the flip side, it has JP¥1.85b in cash leading to net debt of about JP¥1.24b.
How Healthy Is STG's Balance Sheet?
According to the last reported balance sheet, STG had liabilities of JP¥2.72b due within 12 months, and liabilities of JP¥1.61b due beyond 12 months. Offsetting these obligations, it had cash of JP¥1.85b as well as receivables valued at JP¥916.0m due within 12 months. So it has liabilities totalling JP¥1.56b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since STG has a market capitalization of JP¥3.64b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
View our latest analysis for STG
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).
With net debt sitting at just 1.3 times EBITDA, STG is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 9.3 times the interest expense over the last year. In addition to that, we're happy to report that STG has boosted its EBIT by 69%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is STG's earnings that will influence how the balance sheet holds up in the future. 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 last three years, STG reported free cash flow worth 15% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Our View
On our analysis STG's EBIT growth rate should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that STG is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for STG (of which 2 are significant!) you should know about.
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.