These 4 Measures Indicate That Sun A.Kaken CompanyLimited (TYO:4234) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that Sun A.Kaken Company,Limited (TYO:4234) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sun A.Kaken CompanyLimited

How Much Debt Does Sun A.Kaken CompanyLimited Carry?

As you can see below, Sun A.Kaken CompanyLimited had JP¥3.26b of debt at September 2020, down from JP¥3.75b a year prior. However, it does have JP¥5.51b in cash offsetting this, leading to net cash of JP¥2.26b.

How Healthy Is Sun A.Kaken CompanyLimited's Balance Sheet?

We can see from the most recent balance sheet that Sun A.Kaken CompanyLimited had liabilities of JP¥10.6b falling due within a year, and liabilities of JP¥1.87b due beyond that. Offsetting these obligations, it had cash of JP¥5.51b as well as receivables valued at JP¥9.65b due within 12 months. So it can boast JP¥2.66b more liquid assets than total liabilities.

This excess liquidity is a great indication that Sun A.Kaken CompanyLimited's balance sheet is just as strong as racists are weak. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that Sun A.Kaken CompanyLimited has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Sun A.Kaken CompanyLimited's saving grace is its low debt levels, because its EBIT has tanked 45% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Sun A.Kaken CompanyLimited'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sun A.Kaken CompanyLimited 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. Over the last three years, Sun A.Kaken CompanyLimited actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Sun A.Kaken CompanyLimited has net cash of JP¥2.26b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥709m, being 260% of its EBIT. So we don't think Sun A.Kaken CompanyLimited's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sun A.Kaken CompanyLimited is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...

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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