WashhouseLtd (TSE:6537) Takes On Some Risk With Its Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Washhouse Co.,Ltd. (TSE:6537) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for WashhouseLtd

What Is WashhouseLtd's Net Debt?

As you can see below, WashhouseLtd had JP¥834.0m of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds JP¥1.01b in cash, so it actually has JP¥179.0m net cash.

A Look At WashhouseLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that WashhouseLtd had liabilities of JP¥1.25b due within 12 months and liabilities of JP¥1.12b due beyond that. Offsetting these obligations, it had cash of JP¥1.01b as well as receivables valued at JP¥1.04b due within 12 months. So it has liabilities totalling JP¥313.0m more than its cash and near-term receivables, combined.

Since publicly traded WashhouseLtd shares are worth a total of JP¥2.69b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, WashhouseLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

We also note that WashhouseLtd improved its EBIT from a last year's loss to a positive JP¥14m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since WashhouseLtd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. WashhouseLtd 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 year, WashhouseLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

Although WashhouseLtd'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¥179.0m. So while WashhouseLtd does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for WashhouseLtd (1 is 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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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.