David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Seki Co., Ltd. (TYO:7857) does carry 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. 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 Seki
What Is Seki's Debt?
The image below, which you can click on for greater detail, shows that Seki had debt of JP¥552.0m at the end of September 2020, a reduction from JP¥1.61b over a year. However, it does have JP¥3.77b in cash offsetting this, leading to net cash of JP¥3.22b.
How Strong Is Seki's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Seki had liabilities of JP¥1.58b due within 12 months and liabilities of JP¥1.01b due beyond that. On the other hand, it had cash of JP¥3.77b and JP¥2.19b worth of receivables due within a year. So it can boast JP¥3.37b more liquid assets than total liabilities.
This surplus strongly suggests that Seki 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 means the company is able to handle some adversity. Succinctly put, Seki boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Seki's load is not too heavy, because its EBIT was down 77% over the last year. 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 it is Seki's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Seki 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. During the last three years, Seki burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Seki has net cash of JP¥3.22b, as well as more liquid assets than liabilities. So we are not troubled with Seki's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Seki (1 doesn't sit too well with us!) 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. 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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About TSE:7857
Flawless balance sheet established dividend payer.
