We Think Ishikawa Seisakusho (TSE:6208) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Ishikawa Seisakusho, Ltd. (TSE:6208) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Ishikawa Seisakusho

What Is Ishikawa Seisakusho's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Ishikawa Seisakusho had JP¥10.6b of debt, an increase on JP¥5.84b, over one year. On the flip side, it has JP¥899.0m in cash leading to net debt of about JP¥9.72b.

A Look At Ishikawa Seisakusho's Liabilities

Zooming in on the latest balance sheet data, we can see that Ishikawa Seisakusho had liabilities of JP¥14.3b due within 12 months and liabilities of JP¥2.49b due beyond that. Offsetting these obligations, it had cash of JP¥899.0m as well as receivables valued at JP¥10.1b due within 12 months. So its liabilities total JP¥5.77b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of JP¥9.10b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

Strangely Ishikawa Seisakusho has a sky high EBITDA ratio of 8.7, implying high debt, but a strong interest coverage of 23.7. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Pleasingly, Ishikawa Seisakusho is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 947% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Ishikawa Seisakusho 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. During the last three years, Ishikawa Seisakusho burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While Ishikawa Seisakusho's conversion of EBIT to free cash flow has us nervous. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think Ishikawa Seisakusho's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. We've identified 2 warning signs with Ishikawa Seisakusho (at least 1 which is significant) , and understanding them should be part of your investment process.

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.