These 4 Measures Indicate That Arr Planner (TSE:2983) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Arr Planner Co., Ltd. (TSE:2983) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Arr Planner

What Is Arr Planner's Debt?

As you can see below, Arr Planner had JP¥15.2b of debt, at July 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of JP¥4.20b, its net debt is less, at about JP¥11.0b.

How Strong Is Arr Planner's Balance Sheet?

According to the last reported balance sheet, Arr Planner had liabilities of JP¥16.5b due within 12 months, and liabilities of JP¥4.42b due beyond 12 months. Offsetting this, it had JP¥4.20b in cash and JP¥75.0m in receivables that were due within 12 months. So it has liabilities totalling JP¥16.7b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the JP¥7.58b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Arr Planner would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Arr Planner's net debt to EBITDA ratio is 6.7 which suggests rather high debt levels, but its interest cover of 7.8 times suggests the debt is easily serviced. Our best guess is that the company does indeed have significant debt obligations. Pleasingly, Arr Planner is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 156% gain in the last twelve months. 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 Arr Planner will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Arr Planner saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Arr Planner's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Arr Planner to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 5 warning signs with Arr Planner (at least 2 which are concerning) , and understanding them should be part of your investment process.

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.