Here's Why CEDAR.Co.Ltd (TSE:2435) Has A Meaningful Debt Burden

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.' 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 note that CEDAR.Co.,Ltd. (TSE:2435) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for CEDAR.Co.Ltd

What Is CEDAR.Co.Ltd's Net Debt?

The image below, which you can click on for greater detail, shows that CEDAR.Co.Ltd had debt of JP¥10.3b at the end of June 2024, a reduction from JP¥10.8b over a year. On the flip side, it has JP¥2.33b in cash leading to net debt of about JP¥7.95b.

How Healthy Is CEDAR.Co.Ltd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CEDAR.Co.Ltd had liabilities of JP¥7.19b due within 12 months and liabilities of JP¥12.6b due beyond that. Offsetting this, it had JP¥2.33b in cash and JP¥3.02b in receivables that were due within 12 months. So it has liabilities totalling JP¥14.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the JP¥2.48b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, CEDAR.Co.Ltd would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

CEDAR.Co.Ltd has a rather high debt to EBITDA ratio of 5.1 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.7 times, suggesting it can responsibly service its obligations. However, it should be some comfort for shareholders to recall that CEDAR.Co.Ltd actually grew its EBIT by a hefty 131%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. When analysing debt levels, the balance sheet is the obvious place to start. But it is CEDAR.Co.Ltd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, CEDAR.Co.Ltd recorded free cash flow worth 78% 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.

Our View

While CEDAR.Co.Ltd's level of total liabilities has us nervous. To wit both its EBIT growth rate and conversion of EBIT to free cash flow were encouraging signs. We should also note that Healthcare industry companies like CEDAR.Co.Ltd commonly do use debt without problems. Taking the abovementioned factors together we do think CEDAR.Co.Ltd's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. To that end, you should learn about the 5 warning signs we've spotted with CEDAR.Co.Ltd (including 1 which is significant) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.