Does Koken Boring MachineLtd (TSE:6297) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Koken Boring Machine Co.,Ltd. (TSE:6297) makes use of debt. But is this debt a concern to shareholders?

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What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Koken Boring MachineLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that Koken Boring MachineLtd had JP¥5.54b in debt in December 2024; about the same as the year before. However, it does have JP¥2.08b in cash offsetting this, leading to net debt of about JP¥3.46b.

A Look At Koken Boring MachineLtd's Liabilities

We can see from the most recent balance sheet that Koken Boring MachineLtd had liabilities of JP¥4.90b falling due within a year, and liabilities of JP¥3.91b due beyond that. On the other hand, it had cash of JP¥2.08b and JP¥2.91b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥3.82b.

This is a mountain of leverage relative to its market capitalization of JP¥4.16b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

View our latest analysis for Koken Boring MachineLtd

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Koken Boring MachineLtd has a debt to EBITDA ratio of 4.2 and its EBIT covered its interest expense 5.6 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The bad news is that Koken Boring MachineLtd saw its EBIT decline by 16% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Koken Boring MachineLtd 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Koken Boring MachineLtd saw substantial negative free cash flow, in total. 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

On the face of it, Koken Boring MachineLtd's EBIT growth rate left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its interest cover is not so bad. We're quite clear that we consider Koken Boring MachineLtd to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 4 warning signs for Koken Boring MachineLtd you should be aware of, and 2 of them can't be ignored.

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.