Sharp (TSE:6753) Has Debt But No Earnings; Should You Worry?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Sharp Corporation (TSE:6753) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sharp

How Much Debt Does Sharp Carry?

The image below, which you can click on for greater detail, shows that Sharp had debt of JP¥597.4b at the end of June 2024, a reduction from JP¥644.9b over a year. However, it also had JP¥238.1b in cash, and so its net debt is JP¥359.2b.

A Look At Sharp's Liabilities

The latest balance sheet data shows that Sharp had liabilities of JP¥889.6b due within a year, and liabilities of JP¥574.0b falling due after that. Offsetting this, it had JP¥238.1b in cash and JP¥414.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥811.2b.

Given this deficit is actually higher than the company's market capitalization of JP¥634.6b, we think shareholders really should watch Sharp'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 ultimately the future profitability of the business will decide if Sharp can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Sharp had a loss before interest and tax, and actually shrunk its revenue by 8.5%, to JP¥2.3t. We would much prefer see growth.

Caveat Emptor

Importantly, Sharp had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at JP¥19b. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of JP¥157b didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. For riskier companies like Sharp I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.

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

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.