Is Unozawa-gumi Iron Works (TSE:6396) A Risky Investment?

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. As with many other companies Unozawa-gumi Iron Works, Limited (TSE:6396) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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, 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 Unozawa-gumi Iron Works

How Much Debt Does Unozawa-gumi Iron Works Carry?

As you can see below, Unozawa-gumi Iron Works had JP¥2.44b of debt at March 2024, down from JP¥2.54b a year prior. However, its balance sheet shows it holds JP¥2.55b in cash, so it actually has JP¥105.0m net cash.

How Strong Is Unozawa-gumi Iron Works' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Unozawa-gumi Iron Works had liabilities of JP¥2.87b due within 12 months and liabilities of JP¥2.85b due beyond that. Offsetting these obligations, it had cash of JP¥2.55b as well as receivables valued at JP¥2.09b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.08b.

While this might seem like a lot, it is not so bad since Unozawa-gumi Iron Works has a market capitalization of JP¥2.96b, 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. Despite its noteworthy liabilities, Unozawa-gumi Iron Works boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Unozawa-gumi Iron Works grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Unozawa-gumi Iron Works will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Unozawa-gumi Iron Works 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. Over the most recent three years, Unozawa-gumi Iron Works recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Unozawa-gumi Iron Works does have more liabilities than liquid assets, it also has net cash of JP¥105.0m. And it impressed us with its EBIT growth of 43% over the last year. So is Unozawa-gumi Iron Works's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Unozawa-gumi Iron Works you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com