Here's Why Akikawa Foods & Farms (TYO:1380) Can Manage Its Debt Responsibly

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 note that Akikawa Foods & Farms Co., Ltd. (TYO:1380) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Akikawa Foods & Farms

What Is Akikawa Foods & Farms's Debt?

As you can see below, Akikawa Foods & Farms had JP¥2.21b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has JP¥867.0m in cash leading to net debt of about JP¥1.34b.

A Look At Akikawa Foods & Farms' Liabilities

According to the last reported balance sheet, Akikawa Foods & Farms had liabilities of JP¥2.01b due within 12 months, and liabilities of JP¥1.51b due beyond 12 months. On the other hand, it had cash of JP¥867.0m and JP¥1.00b worth of receivables due within a year. So it has liabilities totalling JP¥1.65b more than its cash and near-term receivables, combined.

Akikawa Foods & Farms has a market capitalization of JP¥5.00b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Akikawa Foods & Farms's net debt to EBITDA ratio of about 2.1 suggests only moderate use of debt. And its strong interest cover of 28.3 times, makes us even more comfortable. Pleasingly, Akikawa Foods & Farms is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 189% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Akikawa Foods & Farms's earnings that will influence how the balance sheet holds up in the future. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Akikawa Foods & Farms generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Akikawa Foods & Farms's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Akikawa Foods & Farms's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. Case in point: We've spotted 2 warning signs for Akikawa Foods & Farms you should be aware of.

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.

If you’re looking to trade Akikawa Foods & Farms, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.