These 4 Measures Indicate That Sun Messe (TYO:7883) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Sun Messe Co., Ltd. (TYO:7883) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sun Messe

What Is Sun Messe's Net Debt?

As you can see below, at the end of September 2020, Sun Messe had JP¥1.88b of debt, up from JP¥1.79b a year ago. Click the image for more detail. But on the other hand it also has JP¥2.83b in cash, leading to a JP¥950.0m net cash position.

A Look At Sun Messe's Liabilities

We can see from the most recent balance sheet that Sun Messe had liabilities of JP¥4.26b falling due within a year, and liabilities of JP¥3.40b due beyond that. Offsetting this, it had JP¥2.83b in cash and JP¥2.88b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.94b.

Sun Messe has a market capitalization of JP¥6.01b, 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. While it does have liabilities worth noting, Sun Messe also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Sun Messe if management cannot prevent a repeat of the 64% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sun Messe'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sun Messe 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. Happily for any shareholders, Sun Messe 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.

Summing up

While Sun Messe does have more liabilities than liquid assets, it also has net cash of JP¥950.0m. The cherry on top was that in converted 127% of that EBIT to free cash flow, bringing in JP¥369m. So we are not troubled with Sun Messe's debt use. 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 Sun Messe is showing 2 warning signs in our investment analysis , you should know about...

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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