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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Kao Corporation (TSE:4452) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Kao's Net Debt?
As you can see below, Kao had JP¥131.1b of debt at March 2025, down from JP¥147.4b a year prior. But it also has JP¥278.7b in cash to offset that, meaning it has JP¥147.7b net cash.
How Strong Is Kao's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Kao had liabilities of JP¥449.2b due within 12 months and liabilities of JP¥266.2b due beyond that. On the other hand, it had cash of JP¥278.7b and JP¥224.9b worth of receivables due within a year. So its liabilities total JP¥211.9b more than the combination of its cash and short-term receivables.
Since publicly traded Kao shares are worth a very impressive total of JP¥3.01t, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Kao boasts net cash, so it's fair to say it does not have a heavy debt load!
View our latest analysis for Kao
On top of that, Kao grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. 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 Kao can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Kao 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, Kao generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Summing Up
We could understand if investors are concerned about Kao's liabilities, but we can be reassured by the fact it has has net cash of JP¥147.7b. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in JP¥120b. So we don't think Kao's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Kao, you may well want to click here to check an interactive graph of its earnings per share history.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
Valuation is complex, but we're here to simplify it.
Discover if Kao might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
Access Free AnalysisHave 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.