Is Mitsubishi (TSE:8058) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Mitsubishi Corporation (TSE:8058) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Mitsubishi

What Is Mitsubishi's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Mitsubishi had JP¥5.13t of debt, an increase on JP¥4.89t, over one year. However, it does have JP¥1.35t in cash offsetting this, leading to net debt of about JP¥3.78t.

How Healthy Is Mitsubishi's Balance Sheet?

We can see from the most recent balance sheet that Mitsubishi had liabilities of JP¥8.13t falling due within a year, and liabilities of JP¥5.23t due beyond that. Offsetting these obligations, it had cash of JP¥1.35t as well as receivables valued at JP¥4.24t due within 12 months. So its liabilities total JP¥7.77t more than the combination of its cash and short-term receivables.

Mitsubishi has a very large market capitalization of JP¥14t, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Mitsubishi's net debt is 3.2 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Shareholders should be aware that Mitsubishi's EBIT was down 37% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Mitsubishi 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Mitsubishi actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We feel some trepidation about Mitsubishi's difficulty EBIT growth rate, but we've got positives to focus on, too. To wit both its interest cover and conversion of EBIT to free cash flow were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Mitsubishi is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 Mitsubishi is showing 3 warning signs in our investment analysis , and 1 of those is significant...

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.