These 4 Measures Indicate That Shin-Etsu Chemical (TSE:4063) Is Using Debt Reasonably Well

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.' 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. We note that Shin-Etsu Chemical Co., Ltd. (TSE:4063) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shin-Etsu Chemical

What Is Shin-Etsu Chemical's Net Debt?

As you can see below, Shin-Etsu Chemical had JP¥25.6b of debt at December 2023, down from JP¥33.2b a year prior. But it also has JP¥1.68t in cash to offset that, meaning it has JP¥1.65t net cash.

A Look At Shin-Etsu Chemical's Liabilities

The latest balance sheet data shows that Shin-Etsu Chemical had liabilities of JP¥482.5b due within a year, and liabilities of JP¥214.7b falling due after that. On the other hand, it had cash of JP¥1.68t and JP¥512.7b worth of receivables due within a year. So it can boast JP¥1.49t more liquid assets than total liabilities.

This surplus suggests that Shin-Etsu Chemical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shin-Etsu Chemical has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Shin-Etsu Chemical's load is not too heavy, because its EBIT was down 25% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shin-Etsu Chemical can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shin-Etsu Chemical 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. During the last three years, Shin-Etsu Chemical produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shin-Etsu Chemical has net cash of JP¥1.65t, as well as more liquid assets than liabilities. So we don't have any problem with Shin-Etsu Chemical's use of debt. 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. Case in point: We've spotted 1 warning sign for Shin-Etsu Chemical you should be aware of.

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.