Wakou Shokuhin (TYO:2813) Has Debt But No Earnings; Should You Worry?

Warren Buffett famously said, '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. Importantly, Wakou Shokuhin Co., Ltd. (TYO:2813) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Wakou Shokuhin

What Is Wakou Shokuhin's Net Debt?

As you can see below, at the end of December 2020, Wakou Shokuhin had JP¥2.90b of debt, up from JP¥2.29b a year ago. Click the image for more detail. On the flip side, it has JP¥1.51b in cash leading to net debt of about JP¥1.39b.

How Strong Is Wakou Shokuhin's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wakou Shokuhin had liabilities of JP¥3.93b due within 12 months and liabilities of JP¥1.67b due beyond that. Offsetting these obligations, it had cash of JP¥1.51b as well as receivables valued at JP¥2.03b due within 12 months. So it has liabilities totalling JP¥2.05b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of JP¥2.20b, so it does suggest shareholders should keep an eye on Wakou Shokuhin's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Wakou Shokuhin 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.

Over 12 months, Wakou Shokuhin made a loss at the EBIT level, and saw its revenue drop to JP¥10b, which is a fall of 7.9%. That's not what we would hope to see.

Caveat Emptor

Importantly, Wakou Shokuhin had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at JP¥202m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through JP¥833m of cash over the last year. So in short it's a really risky stock. 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 Wakou Shokuhin has 3 warning signs (and 1 which is significant) 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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