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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Nippon Seiro Co., Ltd. (TSE:5010) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Nippon Seiro
What Is Nippon Seiro's Net Debt?
As you can see below, Nippon Seiro had JPĀ„19.6b of debt at March 2024, down from JPĀ„20.4b a year prior. On the flip side, it has JPĀ„1.78b in cash leading to net debt of about JPĀ„17.8b.
How Strong Is Nippon Seiro's Balance Sheet?
According to the last reported balance sheet, Nippon Seiro had liabilities of JPĀ„17.1b due within 12 months, and liabilities of JPĀ„8.05b due beyond 12 months. Offsetting these obligations, it had cash of JPĀ„1.78b as well as receivables valued at JPĀ„2.74b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JPĀ„20.6b.
The deficiency here weighs heavily on the JPĀ„3.99b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Nippon Seiro would probably need a major re-capitalization if its creditors were to demand repayment.
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.
Nippon Seiro has a rather high debt to EBITDA ratio of 7.9 which suggests a meaningful debt load. However, its interest coverage of 3.2 is reasonably strong, which is a good sign. However, the silver lining was that Nippon Seiro achieved a positive EBIT of JPĀ„1.2b in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nippon Seiro'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 company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Looking at the most recent year, Nippon Seiro recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
On the face of it, Nippon Seiro's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Nippon Seiro's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Nippon Seiro has 3 warning signs (and 2 which are concerning) we think you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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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About TSE:5010
Nippon Seiro
Manufactures and sells petroleum waxes, physically and chemically converted wax products, and fuel oil in Japan and internationally.
Acceptable track record low.
