We Think Shin-Etsu Chemical (TSE:4063) Can Stay On Top Of Its 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Shin-Etsu Chemical Co., Ltd. (TSE:4063) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

Check out our latest analysis for Shin-Etsu Chemical

What Is Shin-Etsu Chemical's Debt?

As you can see below, Shin-Etsu Chemical had JP¥22.7b of debt at June 2024, down from JP¥29.8b a year prior. But it also has JP¥1.72t in cash to offset that, meaning it has JP¥1.70t net cash.

How Healthy Is Shin-Etsu Chemical's Balance Sheet?

The latest balance sheet data shows that Shin-Etsu Chemical had liabilities of JP¥470.5b due within a year, and liabilities of JP¥221.3b falling due after that. On the other hand, it had cash of JP¥1.72t and JP¥496.5b worth of receivables due within a year. So it can boast JP¥1.53t 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.

The modesty of its debt load may become crucial for Shin-Etsu Chemical if management cannot prevent a repeat of the 25% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shin-Etsu Chemical's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shin-Etsu Chemical 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. Over the most recent three years, Shin-Etsu Chemical recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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¥1.70t, 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. However, not all investment risk resides within the balance sheet - far from it. For example - Shin-Etsu Chemical has 1 warning sign we think you should be aware of.

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. 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.