Is TWOSTONE&Sons (TSE:7352) Using Too Much Debt?

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.' 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, TWOSTONE&Sons Inc. (TSE:7352) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

Check out our latest analysis for TWOSTONE&Sons

How Much Debt Does TWOSTONE&Sons Carry?

The image below, which you can click on for greater detail, shows that at August 2024 TWOSTONE&Sons had debt of JP¥1.97b, up from JP¥1.81b in one year. However, it does have JP¥3.70b in cash offsetting this, leading to net cash of JP¥1.73b.

How Healthy Is TWOSTONE&Sons' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that TWOSTONE&Sons had liabilities of JP¥2.87b due within 12 months and liabilities of JP¥1.35b due beyond that. On the other hand, it had cash of JP¥3.70b and JP¥2.01b worth of receivables due within a year. So it can boast JP¥1.49b more liquid assets than total liabilities.

This short term liquidity is a sign that TWOSTONE&Sons could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that TWOSTONE&Sons has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, TWOSTONE&Sons grew its EBIT by 49% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if TWOSTONE&Sons can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While TWOSTONE&Sons has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, TWOSTONE&Sons recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case TWOSTONE&Sons has JP¥1.73b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in JP¥668m. So we don't think TWOSTONE&Sons's use of debt is risky. 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. For instance, we've identified 2 warning signs for TWOSTONE&Sons (1 can't be ignored) you should be aware of.

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.