Asaka RikenLtd (TSE:5724) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 can see that Asaka Riken Co.,Ltd. (TSE:5724) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

What Is Asaka RikenLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Asaka RikenLtd had JP¥3.56b of debt, an increase on JP¥2.48b, over one year. However, it does have JP¥2.86b in cash offsetting this, leading to net debt of about JP¥702.0m.

How Strong Is Asaka RikenLtd's Balance Sheet?

According to the last reported balance sheet, Asaka RikenLtd had liabilities of JP¥2.10b due within 12 months, and liabilities of JP¥3.87b due beyond 12 months. Offsetting this, it had JP¥2.86b in cash and JP¥667.0m in receivables that were due within 12 months. So its liabilities total JP¥2.45b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Asaka RikenLtd has a market capitalization of JP¥4.39b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

Check out our latest analysis for Asaka RikenLtd

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Asaka RikenLtd has a low net debt to EBITDA ratio of only 0.98. And its EBIT covers its interest expense a whopping 26.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Asaka RikenLtd has boosted its EBIT by 46%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Asaka RikenLtd will need earnings to service that debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Asaka RikenLtd reported free cash flow worth 7.1% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Asaka RikenLtd's interest cover was a real positive on this analysis, as was its EBIT growth rate. Having said that, its conversion of EBIT to free cash flow somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think Asaka RikenLtd is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Asaka RikenLtd has 2 warning signs we think you should be aware of.

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.