Does Hosoya Pyro-Engineering (TYO:4274) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Hosoya Pyro-Engineering Co., Ltd. (TYO:4274) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hosoya Pyro-Engineering

What Is Hosoya Pyro-Engineering's Net Debt?

As you can see below, Hosoya Pyro-Engineering had JP¥759.0m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has JP¥824.0m in cash, leading to a JP¥65.0m net cash position.

How Healthy Is Hosoya Pyro-Engineering's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hosoya Pyro-Engineering had liabilities of JP¥738.0m due within 12 months and liabilities of JP¥545.0m due beyond that. Offsetting these obligations, it had cash of JP¥824.0m as well as receivables valued at JP¥166.0m due within 12 months. So its liabilities total JP¥293.0m more than the combination of its cash and short-term receivables.

Since publicly traded Hosoya Pyro-Engineering shares are worth a total of JP¥5.16b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Hosoya Pyro-Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Hosoya Pyro-Engineering grew its EBIT by 44% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hosoya Pyro-Engineering will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hosoya Pyro-Engineering 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, Hosoya Pyro-Engineering produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about Hosoya Pyro-Engineering's liabilities, but we can be reassured by the fact it has has net cash of JP¥65.0m. And it impressed us with its EBIT growth of 44% over the last year. So is Hosoya Pyro-Engineering's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Hosoya Pyro-Engineering .

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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This article by Simply Wall St is general in nature. 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.
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