We Think Nissui (TSE:1332) Is Taking Some Risk With Its 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. We note that Nissui Corporation (TSE:1332) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Nissui

How Much Debt Does Nissui Carry?

The chart below, which you can click on for greater detail, shows that Nissui had JP¥219.0b in debt in December 2023; about the same as the year before. However, because it has a cash reserve of JP¥10.3b, its net debt is less, at about JP¥208.7b.

How Healthy Is Nissui's Balance Sheet?

The latest balance sheet data shows that Nissui had liabilities of JP¥213.1b due within a year, and liabilities of JP¥145.0b falling due after that. On the other hand, it had cash of JP¥10.3b and JP¥122.4b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥225.5b.

This deficit is considerable relative to its market capitalization of JP¥295.6b, so it does suggest shareholders should keep an eye on Nissui's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Nissui's net debt is 4.3 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 16.8 is very high, suggesting that the interest expense on the debt is currently quite low. We saw Nissui grow its EBIT by 6.6% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nissui can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Nissui created free cash flow amounting to 7.7% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Nissui's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Nissui is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. Case in point: We've spotted 2 warning signs for Nissui you should be aware of, and 1 of them is a bit unpleasant.

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.