Does Life (TSE:8194) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Life Corporation (TSE:8194) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Life

What Is Life's Net Debt?

As you can see below, Life had JP¥49.7b of debt at February 2024, down from JP¥70.2b a year prior. On the flip side, it has JP¥8.61b in cash leading to net debt of about JP¥41.1b.

How Healthy Is Life's Balance Sheet?

The latest balance sheet data shows that Life had liabilities of JP¥118.2b due within a year, and liabilities of JP¥32.1b falling due after that. Offsetting these obligations, it had cash of JP¥8.61b as well as receivables valued at JP¥41.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥100.1b.

While this might seem like a lot, it is not so bad since Life has a market capitalization of JP¥185.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Life's net debt is only 1.0 times its EBITDA. And its EBIT covers its interest expense a whopping 3k times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Life has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Life's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept 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, Life recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Life's interest cover was a real positive on this analysis, as was its EBIT growth rate. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. Considering this range of data points, we think Life is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Over time, share prices tend to follow earnings per share, so if you're interested in Life, you may well want to click here to check an interactive graph of its earnings per share history.

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.