These 4 Measures Indicate That Showa Paxxs (TYO:3954) Is Using Debt Safely

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Showa Paxxs Corporation (TYO:3954) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Showa Paxxs

How Much Debt Does Showa Paxxs Carry?

The chart below, which you can click on for greater detail, shows that Showa Paxxs had JP¥1.26b in debt in September 2020; about the same as the year before. But on the other hand it also has JP¥7.71b in cash, leading to a JP¥6.45b net cash position.

How Healthy Is Showa Paxxs' Balance Sheet?

We can see from the most recent balance sheet that Showa Paxxs had liabilities of JP¥6.76b falling due within a year, and liabilities of JP¥1.83b due beyond that. Offsetting these obligations, it had cash of JP¥7.71b as well as receivables valued at JP¥6.00b due within 12 months. So it can boast JP¥5.12b more liquid assets than total liabilities.

This luscious liquidity implies that Showa Paxxs' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Showa Paxxs boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Showa Paxxs has seen its EBIT plunge 14% in the last twelve months. 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 it is Showa Paxxs'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 company can only pay off debt with cold hard cash, not accounting profits. While Showa Paxxs 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, Showa Paxxs generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Showa Paxxs has JP¥6.45b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥1.1b, being 83% of its EBIT. So is Showa Paxxs's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Showa Paxxs 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. 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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