Does ITOCHU (TSE:8001) Have A Healthy Balance Sheet?

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. We note that ITOCHU Corporation (TSE:8001) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

We've discovered 1 warning sign about ITOCHU. View them for free.

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is ITOCHU's Net Debt?

As you can see below, at the end of December 2024, ITOCHU had JP¥3.78t of debt, up from JP¥3.32t a year ago. Click the image for more detail. However, it also had JP¥667.5b in cash, and so its net debt is JP¥3.11t.

How Strong Is ITOCHU's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ITOCHU had liabilities of JP¥4.83t due within 12 months and liabilities of JP¥4.54t due beyond that. On the other hand, it had cash of JP¥667.5b and JP¥3.37t worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥5.34t.

ITOCHU has a very large market capitalization of JP¥9.81t, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

View our latest analysis for ITOCHU

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

ITOCHU's net debt is 3.5 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 1k times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. We saw ITOCHU grow its EBIT by 5.2% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 ITOCHU'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, ITOCHU actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that ITOCHU's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that ITOCHU can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Case in point: We've spotted 1 warning sign for ITOCHU you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.