Does SMS (TSE:2175) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that SMS Co., Ltd. (TSE:2175) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for SMS

What Is SMS's Net Debt?

You can click the graphic below for the historical numbers, but it shows that SMS had JP¥6.15b of debt in June 2024, down from JP¥8.05b, one year before. However, its balance sheet shows it holds JP¥18.2b in cash, so it actually has JP¥12.1b net cash.

A Look At SMS' Liabilities

According to the last reported balance sheet, SMS had liabilities of JP¥22.4b due within 12 months, and liabilities of JP¥6.99b due beyond 12 months. Offsetting this, it had JP¥18.2b in cash and JP¥19.4b in receivables that were due within 12 months. So it can boast JP¥8.28b more liquid assets than total liabilities.

This surplus suggests that SMS has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, SMS boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that SMS saw its EBIT decline by 4.8% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine SMS'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, a company can only pay off debt with cold hard cash, not accounting profits. SMS 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 last three years, SMS recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case SMS has JP¥12.1b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in JP¥6.1b. So is SMS's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of SMS's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.