Health Check: How Prudently Does Towa Food Service (TYO:3329) Use Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Towa Food Service Co., Ltd. (TYO:3329) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Towa Food Service

What Is Towa Food Service's Net Debt?

The image below, which you can click on for greater detail, shows that at October 2020 Towa Food Service had debt of JP¥500.0m, up from none in one year. But on the other hand it also has JP¥1.96b in cash, leading to a JP¥1.46b net cash position.

A Look At Towa Food Service's Liabilities

The latest balance sheet data shows that Towa Food Service had liabilities of JP¥912.0m due within a year, and liabilities of JP¥1.01b falling due after that. Offsetting these obligations, it had cash of JP¥1.96b as well as receivables valued at JP¥356.0m due within 12 months. So it actually has JP¥395.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Towa Food Service could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Towa Food Service has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Towa Food Service will need earnings to service that debt. 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.

In the last year Towa Food Service had a loss before interest and tax, and actually shrunk its revenue by 31%, to JP¥7.9b. To be frank that doesn't bode well.

So How Risky Is Towa Food Service?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Towa Food Service had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through JP¥411m of cash and made a loss of JP¥250m. With only JP¥1.46b on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Towa Food Service that you should be aware of.

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. 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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