Health Check: How Prudently Does SD ENTERTAINMENTInc (TYO:4650) Use Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, SD ENTERTAINMENT,Inc. (TYO:4650) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SD ENTERTAINMENTInc

What Is SD ENTERTAINMENTInc's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 SD ENTERTAINMENTInc had JP¥4.14b of debt, an increase on JP¥3.75b, over one year. However, it also had JP¥1.11b in cash, and so its net debt is JP¥3.03b.

How Healthy Is SD ENTERTAINMENTInc's Balance Sheet?

The latest balance sheet data shows that SD ENTERTAINMENTInc had liabilities of JP¥2.77b due within a year, and liabilities of JP¥2.62b falling due after that. Offsetting this, it had JP¥1.11b in cash and JP¥267.0m in receivables that were due within 12 months. So its liabilities total JP¥4.02b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's JP¥3.60b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SD ENTERTAINMENTInc 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.

Over 12 months, SD ENTERTAINMENTInc made a loss at the EBIT level, and saw its revenue drop to JP¥3.8b, which is a fall of 18%. We would much prefer see growth.

Caveat Emptor

Not only did SD ENTERTAINMENTInc's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at JP¥167m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of JP¥444m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. Case in point: We've spotted 3 warning signs for SD ENTERTAINMENTInc you should be aware of, and 1 of them is concerning.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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