Sotoh (TSE:3571) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, '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. As with many other companies Sotoh Co., Ltd. (TSE:3571) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Sotoh

How Much Debt Does Sotoh Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Sotoh had debt of JP¥508.0m, up from JP¥159.0m in one year. But on the other hand it also has JP¥3.48b in cash, leading to a JP¥2.98b net cash position.

How Healthy Is Sotoh's Balance Sheet?

According to the last reported balance sheet, Sotoh had liabilities of JP¥2.27b due within 12 months, and liabilities of JP¥2.27b due beyond 12 months. Offsetting these obligations, it had cash of JP¥3.48b as well as receivables valued at JP¥2.05b due within 12 months. So it actually has JP¥988.0m more liquid assets than total liabilities.

This surplus suggests that Sotoh has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Sotoh boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Sotoh turned things around in the last 12 months, delivering and EBIT of JP¥342m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sotoh 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sotoh may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Sotoh saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sotoh has JP¥2.98b in net cash and a decent-looking balance sheet. So we don't have any problem with Sotoh's use of debt. 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. For example, we've discovered 3 warning signs for Sotoh (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com