Katakura & Co-op Agri (TSE:4031) Has No Shortage Of Debt

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.' 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. As with many other companies Katakura & Co-op Agri Corporation (TSE:4031) makes use of debt. But the more important question is: how much risk is that debt creating?

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When Is Debt Dangerous?

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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Katakura & Co-op Agri Carry?

As you can see below, at the end of December 2024, Katakura & Co-op Agri had JP¥14.7b of debt, up from JP¥13.4b a year ago. Click the image for more detail. However, it does have JP¥4.13b in cash offsetting this, leading to net debt of about JP¥10.5b.

A Look At Katakura & Co-op Agri's Liabilities

Zooming in on the latest balance sheet data, we can see that Katakura & Co-op Agri had liabilities of JP¥21.4b due within 12 months and liabilities of JP¥4.45b due beyond that. Offsetting this, it had JP¥4.13b in cash and JP¥8.54b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥13.2b.

The deficiency here weighs heavily on the JP¥7.04b 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. At the end of the day, Katakura & Co-op Agri would probably need a major re-capitalization if its creditors were to demand repayment.

Check out our latest analysis for Katakura & Co-op Agri

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Katakura & Co-op Agri has a rather high debt to EBITDA ratio of 7.1 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.9 times, suggesting it can responsibly service its obligations. One redeeming factor for Katakura & Co-op Agri is that it turned last year's EBIT loss into a gain of JP¥171m, over the last twelve months. 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 Katakura & Co-op Agri 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Katakura & Co-op Agri saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Katakura & Co-op Agri's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Katakura & Co-op Agri has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Katakura & Co-op Agri you should be aware of, and 2 of them don't sit too well with us.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.