Is M3 (TSE:2413) Using Too Much 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.' 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 can see that M3, Inc. (TSE:2413) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for M3

What Is M3's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 M3 had debt of JP¥18.5b, up from none in one year. But it also has JP¥179.8b in cash to offset that, meaning it has JP¥161.3b net cash.

A Look At M3's Liabilities

We can see from the most recent balance sheet that M3 had liabilities of JP¥67.2b falling due within a year, and liabilities of JP¥56.9b due beyond that. Offsetting these obligations, it had cash of JP¥179.8b as well as receivables valued at JP¥51.9b due within 12 months. So it can boast JP¥107.7b more liquid assets than total liabilities.

This surplus suggests that M3 has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, M3 boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that M3 saw its EBIT decline by 6.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if M3 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. M3 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. Over the most recent three years, M3 recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 M3 has net cash of JP¥161.3b, as well as more liquid assets than liabilities. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in JP¥51b. So we don't think M3's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in M3, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

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