Kotobuki Spirits (TSE:2222) Could Easily Take On More Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Kotobuki Spirits Co., Ltd. (TSE:2222) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Kotobuki Spirits

What Is Kotobuki Spirits's Debt?

The image below, which you can click on for greater detail, shows that Kotobuki Spirits had debt of JP¥317.0m at the end of December 2023, a reduction from JP¥557.0m over a year. However, its balance sheet shows it holds JP¥18.0b in cash, so it actually has JP¥17.7b net cash.

How Healthy Is Kotobuki Spirits' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kotobuki Spirits had liabilities of JP¥8.05b due within 12 months and liabilities of JP¥2.43b due beyond that. On the other hand, it had cash of JP¥18.0b and JP¥8.45b worth of receivables due within a year. So it actually has JP¥16.0b more liquid assets than total liabilities.

This short term liquidity is a sign that Kotobuki Spirits could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Kotobuki Spirits has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Kotobuki Spirits grew its EBIT by 100% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Kotobuki Spirits can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Kotobuki Spirits 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. During the last three years, Kotobuki Spirits generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Kotobuki Spirits has net cash of JP¥17.7b, as well as more liquid assets than liabilities. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in JP¥9.0b. So we don't think Kotobuki Spirits's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Kotobuki Spirits's earnings per share history for free.

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.

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

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.