We Think Terasaki ElectricLtd (TSE:6637) Can Manage Its Debt With Ease

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. We can see that Terasaki Electric Co.,Ltd. (TSE:6637) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Terasaki ElectricLtd

What Is Terasaki ElectricLtd's Net Debt?

As you can see below, at the end of September 2024, Terasaki ElectricLtd had JP¥4.16b of debt, up from JP¥2.53b a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥16.7b in cash, so it actually has JP¥12.5b net cash.

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¥15.7b due within 12 months and liabilities of JP¥6.30b due beyond that. Offsetting this, it had JP¥16.7b in cash and JP¥13.6b in receivables that were due within 12 months. So it actually has JP¥8.27b more liquid assets than total liabilities.

It's good to see that Terasaki ElectricLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face 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.

In addition to that, we're happy to report that Terasaki ElectricLtd has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Terasaki ElectricLtd 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Terasaki ElectricLtd 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, Terasaki ElectricLtd reported free cash flow worth 16% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Terasaki ElectricLtd has net cash of JP¥12.5b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 59% over the last year. So we don't think Terasaki ElectricLtd's use of debt is risky. 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. For example, we've discovered 2 warning signs for Terasaki ElectricLtd (1 shouldn't be ignored!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.