Is Sanwa Holdings (TSE:5929) Using Too Much Debt?

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.' 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 can see that Sanwa Holdings Corporation (TSE:5929) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Sanwa Holdings

What Is Sanwa Holdings's Net Debt?

As you can see below, Sanwa Holdings had JP¥46.9b of debt at December 2023, down from JP¥49.5b a year prior. However, its balance sheet shows it holds JP¥97.7b in cash, so it actually has JP¥50.8b net cash.

How Healthy Is Sanwa Holdings' Balance Sheet?

The latest balance sheet data shows that Sanwa Holdings had liabilities of JP¥144.2b due within a year, and liabilities of JP¥64.5b falling due after that. Offsetting this, it had JP¥97.7b in cash and JP¥119.2b in receivables that were due within 12 months. So it actually has JP¥8.18b more liquid assets than total liabilities.

This state of affairs indicates that Sanwa Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the JP¥569.7b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Sanwa Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Sanwa Holdings grew its EBIT at 20% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sanwa Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Sanwa Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Sanwa Holdings produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sanwa Holdings has JP¥50.8b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 20% over the last year. So we don't think Sanwa Holdings's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Sanwa Holdings, you may well want to click here to check an interactive graph of its earnings per share history.

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.