Is S.IshimitsuLtd (TYO:2750) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 S.Ishimitsu & Co.,Ltd. (TYO:2750) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 S.IshimitsuLtd

What Is S.IshimitsuLtd's Net Debt?

As you can see below, S.IshimitsuLtd had JP¥6.84b of debt at December 2020, down from JP¥7.70b a year prior. On the flip side, it has JP¥5.06b in cash leading to net debt of about JP¥1.79b.

A Look At S.IshimitsuLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that S.IshimitsuLtd had liabilities of JP¥12.0b due within 12 months and liabilities of JP¥4.63b due beyond that. Offsetting this, it had JP¥5.06b in cash and JP¥10.5b in receivables that were due within 12 months. So it has liabilities totalling JP¥1.06b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since S.IshimitsuLtd has a market capitalization of JP¥3.48b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

S.IshimitsuLtd's net debt to EBITDA ratio of about 1.8 suggests only moderate use of debt. And its commanding EBIT of 12.9 times its interest expense, implies the debt load is as light as a peacock feather. It is well worth noting that S.IshimitsuLtd's EBIT shot up like bamboo after rain, gaining 45% in the last twelve months. That'll make it easier to manage its debt. 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 S.IshimitsuLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, S.IshimitsuLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, S.IshimitsuLtd's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think S.IshimitsuLtd's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for S.IshimitsuLtd (of which 1 is a bit concerning!) you should know about.

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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