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.' 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 Sokensha Co.,Ltd. (TYO:7413) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for SokenshaLtd
What Is SokenshaLtd's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 SokenshaLtd had JP¥975.0m of debt, an increase on JP¥787.0m, over one year. But on the other hand it also has JP¥1.45b in cash, leading to a JP¥472.0m net cash position.
How Strong Is SokenshaLtd's Balance Sheet?
The latest balance sheet data shows that SokenshaLtd had liabilities of JP¥1.08b due within a year, and liabilities of JP¥810.0m falling due after that. Offsetting this, it had JP¥1.45b in cash and JP¥600.0m in receivables that were due within 12 months. So it actually has JP¥159.0m more liquid assets than total liabilities.
This short term liquidity is a sign that SokenshaLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that SokenshaLtd has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, SokenshaLtd grew its EBIT by 78% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is SokenshaLtd's earnings that will influence how the balance sheet holds up in the future. 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. While SokenshaLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent two years, SokenshaLtd recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that SokenshaLtd has net cash of JP¥472.0m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 78% over the last year. So we don't think SokenshaLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with SokenshaLtd (at least 2 which are potentially serious) , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. 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.
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About TSE:7413
SokenshaLtd
Engages in the wholesale of natural and health foods, and other related products in Japan.
Proven track record with adequate balance sheet.
