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

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. As with many other companies R. C. Core Co., Ltd. (TYO:7837) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for R. C. Core

How Much Debt Does R. C. Core Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 R. C. Core had JP¥5.73b of debt, an increase on JP¥4.07b, over one year. However, because it has a cash reserve of JP¥4.68b, its net debt is less, at about JP¥1.05b.

How Strong Is R. C. Core's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that R. C. Core had liabilities of JP¥6.66b due within 12 months and liabilities of JP¥3.09b due beyond that. Offsetting this, it had JP¥4.68b in cash and JP¥1.05b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥4.03b.

Given this deficit is actually higher than the company's market capitalization of JP¥3.19b, 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. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Over 12 months, R. C. Core reported revenue of JP¥17b, which is a gain of 3.2%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months R. C. Core produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at JP¥41m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of JP¥408m over the last twelve months. 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with R. C. Core (including 2 which are significant) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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