Is Kyoei Security Service (TYO:7058) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Kyoei Security Service Co., Ltd. (TYO:7058) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Kyoei Security Service

What Is Kyoei Security Service's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Kyoei Security Service had debt of JP¥485.0m, up from none in one year. But on the other hand it also has JP¥3.10b in cash, leading to a JP¥2.61b net cash position.

A Look At Kyoei Security Service's Liabilities

The latest balance sheet data shows that Kyoei Security Service had liabilities of JP¥810.0m due within a year, and liabilities of JP¥410.0m falling due after that. On the other hand, it had cash of JP¥3.10b and JP¥677.0m worth of receivables due within a year. So it actually has JP¥2.56b more liquid assets than total liabilities.

This surplus strongly suggests that Kyoei Security Service has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that Kyoei Security Service has more cash than debt is arguably a good indication that it can manage its debt safely.

While Kyoei Security Service doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But it is Kyoei Security Service's earnings that will influence how the balance sheet holds up in the future. 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. Kyoei Security Service 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 most recent three years, Kyoei Security Service recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kyoei Security Service has net cash of JP¥2.61b, as well as more liquid assets than liabilities. So we don't think Kyoei Security Service's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Kyoei Security Service , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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