We Think AmifaLtd (TYO:7800) Can Manage Its Debt With Ease

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.' 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. Importantly, Amifa Co.,Ltd. (TYO:7800) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for AmifaLtd

What Is AmifaLtd's Debt?

As you can see below, AmifaLtd had JP¥157.0m of debt at September 2020, down from JP¥245.0m a year prior. However, its balance sheet shows it holds JP¥1.33b in cash, so it actually has JP¥1.18b net cash.

How Strong Is AmifaLtd's Balance Sheet?

The latest balance sheet data shows that AmifaLtd had liabilities of JP¥423.0m due within a year, and liabilities of JP¥360.0m falling due after that. Offsetting this, it had JP¥1.33b in cash and JP¥395.0m in receivables that were due within 12 months. So it actually has JP¥944.0m more liquid assets than total liabilities.

This surplus liquidity suggests that AmifaLtd's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that AmifaLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact AmifaLtd's saving grace is its low debt levels, because its EBIT has tanked 20% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 AmifaLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. AmifaLtd 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. Happily for any shareholders, AmifaLtd actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case AmifaLtd has JP¥1.18b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥355m, being 103% of its EBIT. So is AmifaLtd's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that AmifaLtd is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

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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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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