Is Souken Ace (TSE:1757) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Souken Ace Co., Ltd. (TSE:1757) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Souken Ace

What Is Souken Ace's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Souken Ace had debt of JP¥953.0m, up from JP¥48.0m in one year. However, it also had JP¥188.0m in cash, and so its net debt is JP¥765.0m.

How Strong Is Souken Ace's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Souken Ace had liabilities of JP¥1.31b due within 12 months and liabilities of JP¥38.0m due beyond that. Offsetting this, it had JP¥188.0m in cash and JP¥785.0m in receivables that were due within 12 months. So it has liabilities totalling JP¥376.0m more than its cash and near-term receivables, combined.

Of course, Souken Ace has a market capitalization of JP¥9.10b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Souken Ace's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Souken Ace had a loss before interest and tax, and actually shrunk its revenue by 54%, to JP¥2.5b. To be frank that doesn't bode well.

Caveat Emptor

While Souken Ace's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost JP¥660m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled JP¥925m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. To that end, you should learn about the 4 warning signs we've spotted with Souken Ace (including 1 which can't be ignored) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.