Nabtesco (TSE:6268) Has A Pretty Healthy Balance Sheet

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.' 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 note that Nabtesco Corporation (TSE:6268) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Nabtesco

What Is Nabtesco's Debt?

The image below, which you can click on for greater detail, shows that Nabtesco had debt of JP¥21.6b at the end of December 2023, a reduction from JP¥23.4b over a year. But on the other hand it also has JP¥77.8b in cash, leading to a JP¥56.3b net cash position.

How Strong Is Nabtesco's Balance Sheet?

According to the last reported balance sheet, Nabtesco had liabilities of JP¥119.5b due within 12 months, and liabilities of JP¥26.7b due beyond 12 months. Offsetting this, it had JP¥77.8b in cash and JP¥84.4b in receivables that were due within 12 months. So it actually has JP¥16.1b more liquid assets than total liabilities.

This surplus suggests that Nabtesco has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Nabtesco boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Nabtesco saw its EBIT decline by 2.4% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Nabtesco can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Nabtesco may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Nabtesco created free cash flow amounting to 14% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nabtesco has net cash of JP¥56.3b, as well as more liquid assets than liabilities. So we are not troubled with Nabtesco's debt use. 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 Nabtesco , 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.