Is Link and Motivation (TSE:2170) 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 Link and Motivation Inc. (TSE:2170) does have debt on its balance sheet. But is this debt a concern to shareholders?

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

Check out our latest analysis for Link and Motivation

How Much Debt Does Link and Motivation Carry?

The chart below, which you can click on for greater detail, shows that Link and Motivation had JP¥8.59b in debt in March 2024; about the same as the year before. On the flip side, it has JP¥7.35b in cash leading to net debt of about JP¥1.24b.

A Look At Link and Motivation's Liabilities

Zooming in on the latest balance sheet data, we can see that Link and Motivation had liabilities of JP¥10.5b due within 12 months and liabilities of JP¥7.68b due beyond that. Offsetting this, it had JP¥7.35b in cash and JP¥3.67b in receivables that were due within 12 months. So it has liabilities totalling JP¥7.13b more than its cash and near-term receivables, combined.

Since publicly traded Link and Motivation shares are worth a total of JP¥45.0b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Link and Motivation's net debt is only 0.19 times its EBITDA. And its EBIT covers its interest expense a whopping 86.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Link and Motivation grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Link and Motivation's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Link and Motivation produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Link and Motivation's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Link and Motivation seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Link and Motivation, you may well want to click here to check an interactive graph of its earnings per share history.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com