Is JSS (TYO:6074) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that JSS Corporation (TYO:6074) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for JSS

What Is JSS's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 JSS had JP¥2.25b of debt, an increase on JP¥1.79b, over one year. However, it does have JP¥624.0m in cash offsetting this, leading to net debt of about JP¥1.63b.

A Look At JSS' Liabilities

Zooming in on the latest balance sheet data, we can see that JSS had liabilities of JP¥2.75b due within 12 months and liabilities of JP¥1.51b due beyond that. On the other hand, it had cash of JP¥624.0m and JP¥137.0m worth of receivables due within a year. So it has liabilities totalling JP¥3.49b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the JP¥1.65b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, JSS would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 6.0, it's fair to say JSS does have a significant amount of debt. However, its interest coverage of 6.7 is reasonably strong, which is a good sign. Shareholders should be aware that JSS's EBIT was down 92% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is JSS's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, JSS created free cash flow amounting to 9.0% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

To be frank both JSS's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Taking into account all the aforementioned factors, it looks like JSS has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. For instance, we've identified 3 warning signs for JSS (2 are concerning) 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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