David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Atomix Co.,Ltd. (TYO:4625) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does AtomixLtd Carry?
You can click the graphic below for the historical numbers, but it shows that AtomixLtd had JP¥317.0m of debt in December 2020, down from JP¥446.0m, one year before. However, its balance sheet shows it holds JP¥2.96b in cash, so it actually has JP¥2.64b net cash.
A Look At AtomixLtd's Liabilities
We can see from the most recent balance sheet that AtomixLtd had liabilities of JP¥3.70b falling due within a year, and liabilities of JP¥699.0m due beyond that. Offsetting this, it had JP¥2.96b in cash and JP¥3.45b in receivables that were due within 12 months. So it actually has JP¥2.00b more liquid assets than total liabilities.
This surplus liquidity suggests that AtomixLtd's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that AtomixLtd has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that AtomixLtd has boosted its EBIT by 57%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since AtomixLtd will need earnings to service that debt. 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While AtomixLtd 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. Happily for any shareholders, AtomixLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case AtomixLtd has JP¥2.64b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 108% of that EBIT to free cash flow, bringing in JP¥657m. The bottom line is that AtomixLtd's use of debt is absolutely fine. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for AtomixLtd you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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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