Is Kokuyo (TSE:7984) Using Too Much Debt?

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.' 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 note that Kokuyo Co., Ltd. (TSE:7984) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Kokuyo Carry?

You can click the graphic below for the historical numbers, but it shows that Kokuyo had JP¥4.18b of debt in December 2024, down from JP¥9.24b, one year before. However, its balance sheet shows it holds JP¥132.3b in cash, so it actually has JP¥128.2b net cash.

How Strong Is Kokuyo's Balance Sheet?

According to the last reported balance sheet, Kokuyo had liabilities of JP¥87.7b due within 12 months, and liabilities of JP¥11.2b due beyond 12 months. Offsetting this, it had JP¥132.3b in cash and JP¥75.4b in receivables that were due within 12 months. So it actually has JP¥108.8b more liquid assets than total liabilities.

This excess liquidity is a great indication that Kokuyo's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Kokuyo has more cash than debt is arguably a good indication that it can manage its debt safely.

See our latest analysis for Kokuyo

But the other side of the story is that Kokuyo saw its EBIT decline by 7.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Kokuyo 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Kokuyo 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 most recent three years, Kokuyo recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Kokuyo has net cash of JP¥128.2b, as well as more liquid assets than liabilities. So we don't think Kokuyo's use of debt is risky. 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 instance, we've identified 2 warning signs for Kokuyo that 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.