Is Yamax (TYO:5285) A Risky Investment?

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 Yamax Corp. (TYO:5285) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Yamax

What Is Yamax's Net Debt?

As you can see below, Yamax had JP¥2.45b of debt at September 2020, down from JP¥2.89b a year prior. On the flip side, it has JP¥967.0m in cash leading to net debt of about JP¥1.48b.

How Healthy Is Yamax's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yamax had liabilities of JP¥6.54b due within 12 months and liabilities of JP¥1.70b due beyond that. Offsetting these obligations, it had cash of JP¥967.0m as well as receivables valued at JP¥3.01b due within 12 months. So its liabilities total JP¥4.26b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the JP¥2.21b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Yamax would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Yamax's moderate net debt to EBITDA ratio ( being 1.8), indicates prudence when it comes to debt. And its commanding EBIT of 36.5 times its interest expense, implies the debt load is as light as a peacock feather. Shareholders should be aware that Yamax's EBIT was down 32% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Yamax'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. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Yamax 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.

Our View

On the face of it, Yamax's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Yamax stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. To that end, you should learn about the 4 warning signs we've spotted with Yamax (including 1 which shouldn't be ignored) .

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.

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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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