Is Terasaki ElectricLtd (TSE:6637) Using Too Much Debt?

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.' 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. Importantly, Terasaki Electric Co.,Ltd. (TSE:6637) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Terasaki ElectricLtd

What Is Terasaki ElectricLtd's Debt?

As you can see below, at the end of March 2024, Terasaki ElectricLtd had JP¥3.29b of debt, up from JP¥2.97b a year ago. Click the image for more detail. But on the other hand it also has JP¥13.2b in cash, leading to a JP¥9.92b net cash position.

A Look At Terasaki ElectricLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Terasaki ElectricLtd had liabilities of JP¥15.3b due within 12 months and liabilities of JP¥5.95b due beyond that. On the other hand, it had cash of JP¥13.2b and JP¥15.9b worth of receivables due within a year. So it actually has JP¥7.86b more liquid assets than total liabilities.

This excess liquidity suggests that Terasaki ElectricLtd is taking a careful approach to debt. 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 Terasaki ElectricLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Terasaki ElectricLtd grew its EBIT by 72% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Terasaki ElectricLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Terasaki ElectricLtd 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 last three years, Terasaki ElectricLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Terasaki ElectricLtd has JP¥9.92b in net cash and a decent-looking balance sheet. And we liked the look of last year's 72% year-on-year EBIT growth. So is Terasaki ElectricLtd's debt a risk? It doesn't seem so to us. 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 Terasaki ElectricLtd is showing 2 warning signs 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.

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

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