We Think Care ServiceLtd (TYO:2425) Can Manage Its Debt With Ease

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Care Service Co.,Ltd. (TYO:2425) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Care ServiceLtd

What Is Care ServiceLtd's Net Debt?

As you can see below, at the end of December 2020, Care ServiceLtd had JP¥584.0m of debt, up from JP¥452.0m a year ago. Click the image for more detail. However, it does have JP¥1.41b in cash offsetting this, leading to net cash of JP¥828.0m.

A Look At Care ServiceLtd's Liabilities

We can see from the most recent balance sheet that Care ServiceLtd had liabilities of JP¥1.49b falling due within a year, and liabilities of JP¥372.0m due beyond that. Offsetting this, it had JP¥1.41b in cash and JP¥1.39b in receivables that were due within 12 months. So it can boast JP¥937.0m more liquid assets than total liabilities.

This surplus suggests that Care ServiceLtd is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Care ServiceLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Care ServiceLtd has increased its EBIT by 3.4% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Care ServiceLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Care ServiceLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Care ServiceLtd produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Care ServiceLtd has net cash of JP¥828.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in JP¥224m. So we don't think Care ServiceLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Care ServiceLtd , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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