Here's Why CASSINA IXC (TYO:2777) Can Manage Its Debt Responsibly

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.' 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. As with many other companies CASSINA IXC. Ltd. (TYO:2777) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for CASSINA IXC

What Is CASSINA IXC's Debt?

As you can see below, CASSINA IXC had JP¥2.13b of debt at September 2020, down from JP¥2.25b a year prior. However, its balance sheet shows it holds JP¥3.38b in cash, so it actually has JP¥1.25b net cash.

A Look At CASSINA IXC's Liabilities

We can see from the most recent balance sheet that CASSINA IXC had liabilities of JP¥3.49b falling due within a year, and liabilities of JP¥1.60b due beyond that. Offsetting these obligations, it had cash of JP¥3.38b as well as receivables valued at JP¥596.0m due within 12 months. So its liabilities total JP¥1.10b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since CASSINA IXC has a market capitalization of JP¥2.89b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, CASSINA IXC also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact CASSINA IXC's saving grace is its low debt levels, because its EBIT has tanked 40% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since CASSINA IXC 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 company can only pay off debt with cold hard cash, not accounting profits. CASSINA IXC 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. During the last three years, CASSINA IXC produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although CASSINA IXC's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥1.25b. So we are not troubled with CASSINA IXC's debt use. 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. Be aware that CASSINA IXC is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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