Is Nihon Seimitsu (TYO:7771) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Nihon Seimitsu Co., Ltd. (TYO:7771) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Nihon Seimitsu

How Much Debt Does Nihon Seimitsu Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Nihon Seimitsu had debt of JP¥3.19b, up from JP¥3.03b in one year. However, it does have JP¥898.0m in cash offsetting this, leading to net debt of about JP¥2.30b.

A Look At Nihon Seimitsu's Liabilities

We can see from the most recent balance sheet that Nihon Seimitsu had liabilities of JP¥3.04b falling due within a year, and liabilities of JP¥998.0m due beyond that. Offsetting this, it had JP¥898.0m in cash and JP¥596.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥2.54b.

When you consider that this deficiency exceeds the company's JP¥1.76b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nihon Seimitsu's earnings that will influence how the balance sheet holds up in the future. 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.

In the last year Nihon Seimitsu had a loss before interest and tax, and actually shrunk its revenue by 32%, to JP¥4.9b. To be frank that doesn't bode well.

Caveat Emptor

While Nihon Seimitsu's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping JP¥536m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through JP¥321m in negative free cash flow over the last year. So suffice it to say we consider the stock to be 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. Case in point: We've spotted 3 warning signs for Nihon Seimitsu you should be aware of, and 1 of them shouldn't be ignored.

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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