Kitagawa SeikiLtd (TSE:6327) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, '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. Importantly, Kitagawa Seiki Co.,Ltd. (TSE:6327) does carry debt. But the real question is whether this debt is making the company risky.

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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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Kitagawa SeikiLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Kitagawa SeikiLtd had debt of JP¥1.38b at the end of December 2024, a reduction from JP¥1.50b over a year. But on the other hand it also has JP¥3.52b in cash, leading to a JP¥2.14b net cash position.

How Strong Is Kitagawa SeikiLtd's Balance Sheet?

The latest balance sheet data shows that Kitagawa SeikiLtd had liabilities of JP¥3.28b due within a year, and liabilities of JP¥706.0m falling due after that. On the other hand, it had cash of JP¥3.52b and JP¥2.20b worth of receivables due within a year. So it actually has JP¥1.73b more liquid assets than total liabilities.

This surplus strongly suggests that Kitagawa SeikiLtd has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Kitagawa SeikiLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

See our latest analysis for Kitagawa SeikiLtd

On the other hand, Kitagawa SeikiLtd's EBIT dived 20%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kitagawa SeikiLtd's ability to maintain a healthy balance sheet going forward. 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. While Kitagawa SeikiLtd 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. During the last three years, Kitagawa SeikiLtd generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd 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 Kitagawa SeikiLtd has net cash of JP¥2.14b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥325m, being 93% of its EBIT. So is Kitagawa SeikiLtd's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Kitagawa SeikiLtd is showing 2 warning signs in our investment analysis , and 1 of those is significant...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.