Health Check: How Prudently Does R. C. Core (TYO:7837) Use Debt?

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.' 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, R. C. Core Co., Ltd. (TYO:7837) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for R. C. Core

How Much Debt Does R. C. Core Carry?

The image below, which you can click on for greater detail, shows that at September 2020 R. C. Core had debt of JP¥6.33b, up from JP¥3.57b in one year. However, because it has a cash reserve of JP¥5.30b, its net debt is less, at about JP¥1.03b.

A Look At R. C. Core's Liabilities

According to the last reported balance sheet, R. C. Core had liabilities of JP¥7.49b due within 12 months, and liabilities of JP¥3.09b due beyond 12 months. Offsetting this, it had JP¥5.30b in cash and JP¥1.27b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥4.01b.

Given this deficit is actually higher than the company's market capitalization of JP¥3.00b, we think shareholders really should watch R. C. Core's debt levels, like a parent watching their child ride a bike for the first time. 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since R. C. Core 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.

In the last year R. C. Core wasn't profitable at an EBIT level, but managed to grow its revenue by 16%, to JP¥17b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, R. C. Core had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost JP¥16m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous 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¥408m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 5 warning signs for R. C. Core (of which 2 are potentially serious!) you should know about.

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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