KIMURA KOHKILtd (TSE:6231) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 KIMURA KOHKI Co.,Ltd. (TSE:6231) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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 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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for KIMURA KOHKILtd

What Is KIMURA KOHKILtd's Debt?

The chart below, which you can click on for greater detail, shows that KIMURA KOHKILtd had JP¥4.47b in debt in March 2024; about the same as the year before. However, it does have JP¥1.72b in cash offsetting this, leading to net debt of about JP¥2.75b.

How Strong Is KIMURA KOHKILtd's Balance Sheet?

The latest balance sheet data shows that KIMURA KOHKILtd had liabilities of JP¥5.10b due within a year, and liabilities of JP¥5.41b falling due after that. On the other hand, it had cash of JP¥1.72b and JP¥5.63b worth of receivables due within a year. So it has liabilities totalling JP¥3.17b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since KIMURA KOHKILtd has a market capitalization of JP¥14.6b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

KIMURA KOHKILtd has a low net debt to EBITDA ratio of only 0.88. And its EBIT covers its interest expense a whopping 67.0 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that KIMURA KOHKILtd has boosted its EBIT by 70%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is KIMURA KOHKILtd'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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, KIMURA KOHKILtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen KIMURA KOHKILtd is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think KIMURA KOHKILtd is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 1 warning sign with KIMURA KOHKILtd , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

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