Central Sports (TSE:4801) Seems To Use Debt Rather Sparingly

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. We can see that Central Sports Co., Ltd. (TSE:4801) does use debt in its business. 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. 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. 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.

View our latest analysis for Central Sports

How Much Debt Does Central Sports Carry?

As you can see below, Central Sports had JP¥2.03b of debt at March 2024, down from JP¥3.86b a year prior. But it also has JP¥7.40b in cash to offset that, meaning it has JP¥5.37b net cash.

How Strong Is Central Sports' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Central Sports had liabilities of JP¥10.2b due within 12 months and liabilities of JP¥6.64b due beyond that. On the other hand, it had cash of JP¥7.40b and JP¥1.80b worth of receivables due within a year. So its liabilities total JP¥7.61b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Central Sports is worth JP¥24.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Central Sports also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Central Sports grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Central Sports 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Central Sports has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Central Sports actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Central Sports's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥5.37b. And it impressed us with free cash flow of JP¥2.1b, being 159% of its EBIT. So is Central Sports's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Central Sports is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

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