Rheon Automatic Machinery (TSE:6272) Has A Rock Solid Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Rheon Automatic Machinery Co., Ltd. (TSE:6272) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Rheon Automatic Machinery

What Is Rheon Automatic Machinery's Debt?

As you can see below, Rheon Automatic Machinery had JP¥1.61b of debt at March 2024, down from JP¥1.93b a year prior. However, it does have JP¥13.6b in cash offsetting this, leading to net cash of JP¥12.0b.

How Strong Is Rheon Automatic Machinery's Balance Sheet?

The latest balance sheet data shows that Rheon Automatic Machinery had liabilities of JP¥6.74b due within a year, and liabilities of JP¥1.95b falling due after that. Offsetting these obligations, it had cash of JP¥13.6b as well as receivables valued at JP¥3.21b due within 12 months. So it actually has JP¥8.11b more liquid assets than total liabilities.

This surplus suggests that Rheon Automatic Machinery is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Rheon Automatic Machinery has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Rheon Automatic Machinery grew its EBIT by 62% over the last twelve months, and that growth will make it easier to handle its 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 Rheon Automatic Machinery 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Rheon Automatic Machinery 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. Over the last three years, Rheon Automatic Machinery recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Rheon Automatic Machinery has net cash of JP¥12.0b, as well as more liquid assets than liabilities. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in JP¥3.1b. The bottom line is that we do not find Rheon Automatic Machinery's debt levels at all concerning. 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. Be aware that Rheon Automatic Machinery is showing 1 warning sign in our investment analysis , you should know about...

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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