Shidax (TYO:4837) Takes On Some Risk With Its Use Of Debt

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.' 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. As with many other companies Shidax Corporation (TYO:4837) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Shidax

What Is Shidax's Net Debt?

As you can see below, Shidax had JP¥9.11b of debt at December 2020, down from JP¥13.5b a year prior. However, its balance sheet shows it holds JP¥9.57b in cash, so it actually has JP¥460.0m net cash.

A Look At Shidax's Liabilities

According to the last reported balance sheet, Shidax had liabilities of JP¥24.9b due within 12 months, and liabilities of JP¥7.09b due beyond 12 months. Offsetting these obligations, it had cash of JP¥9.57b as well as receivables valued at JP¥13.1b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥9.30b.

This deficit is considerable relative to its market capitalization of JP¥11.8b, so it does suggest shareholders should keep an eye on Shidax's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Shidax also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Shidax's EBIT fell a jaw-dropping 85% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Shidax 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shidax may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Shidax barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing up

While Shidax does have more liabilities than liquid assets, it also has net cash of JP¥460.0m. Despite its cash we think that Shidax seems to struggle to grow its EBIT, so we are wary of the stock. 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. Be aware that Shidax is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

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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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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