We Think M3 (TSE:2413) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that M3, Inc. (TSE:2413) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for M3

What Is M3's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 M3 had JP¥24.4b of debt, an increase on none, over one year. However, it does have JP¥148.1b in cash offsetting this, leading to net cash of JP¥123.7b.

How Strong Is M3's Balance Sheet?

According to the last reported balance sheet, M3 had liabilities of JP¥64.2b due within 12 months, and liabilities of JP¥62.9b due beyond 12 months. Offsetting this, it had JP¥148.1b in cash and JP¥49.5b in receivables that were due within 12 months. So it actually has JP¥70.6b 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. Simply put, the fact that M3 has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, M3's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While M3 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, M3 produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that M3 has net cash of JP¥123.7b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥49b, being 76% of its EBIT. So is M3's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - M3 has 1 warning sign we think you should be aware of.

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. 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.