Does Ishikawa Seisakusho (TSE:6208) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Ishikawa Seisakusho, Ltd. (TSE:6208) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ishikawa Seisakusho

What Is Ishikawa Seisakusho's Debt?

As you can see below, at the end of March 2024, Ishikawa Seisakusho had JP¥6.23b of debt, up from JP¥4.10b a year ago. Click the image for more detail. On the flip side, it has JP¥954.0m in cash leading to net debt of about JP¥5.27b.

How Strong Is Ishikawa Seisakusho's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ishikawa Seisakusho had liabilities of JP¥10.3b due within 12 months and liabilities of JP¥1.59b due beyond that. Offsetting these obligations, it had cash of JP¥954.0m as well as receivables valued at JP¥4.66b due within 12 months. So its liabilities total JP¥6.29b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of JP¥9.63b, so it does suggest shareholders should keep an eye on Ishikawa Seisakusho's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

As it happens Ishikawa Seisakusho has a fairly concerning net debt to EBITDA ratio of 10.1 but very strong interest coverage of 36.3. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. We note that Ishikawa Seisakusho grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ishikawa Seisakusho will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Ishikawa Seisakusho's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Ishikawa Seisakusho's net debt to EBITDA 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 factors mentioned above, we do feel a bit cautious about Ishikawa Seisakusho's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Ishikawa Seisakusho you should be aware of, and 3 of them are potentially serious.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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

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