Naikai Zosen (TSE:7018) Takes On Some Risk With Its Use Of Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Naikai Zosen Corporation (TSE:7018) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Naikai Zosen

What Is Naikai Zosen's Debt?

You can click the graphic below for the historical numbers, but it shows that Naikai Zosen had JP¥5.56b of debt in December 2024, down from JP¥9.78b, one year before. However, its balance sheet shows it holds JP¥12.9b in cash, so it actually has JP¥7.37b net cash.

How Strong Is Naikai Zosen's Balance Sheet?

The latest balance sheet data shows that Naikai Zosen had liabilities of JP¥27.4b due within a year, and liabilities of JP¥5.78b falling due after that. Offsetting these obligations, it had cash of JP¥12.9b as well as receivables valued at JP¥14.8b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥5.41b.

While this might seem like a lot, it is not so bad since Naikai Zosen has a market capitalization of JP¥10.1b, 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. While it does have liabilities worth noting, Naikai Zosen also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Naikai Zosen's saving grace is its low debt levels, because its EBIT has tanked 39% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Naikai Zosen 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. Naikai Zosen 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, Naikai Zosen reported free cash flow worth 19% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

Although Naikai Zosen's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥7.37b. So although we see some areas for improvement, we're not too worried about Naikai Zosen's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Naikai Zosen that you should be aware of before investing here.

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.