Here's Why Mitsui Chemicals (TSE:4183) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Mitsui Chemicals, Inc. (TSE:4183) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Mitsui Chemicals

What Is Mitsui Chemicals's Debt?

The chart below, which you can click on for greater detail, shows that Mitsui Chemicals had JP¥756.8b in debt in March 2024; about the same as the year before. However, it does have JP¥249.5b in cash offsetting this, leading to net debt of about JP¥507.2b.

A Look At Mitsui Chemicals' Liabilities

According to the last reported balance sheet, Mitsui Chemicals had liabilities of JP¥661.2b due within 12 months, and liabilities of JP¥569.8b due beyond 12 months. On the other hand, it had cash of JP¥249.5b and JP¥381.4b worth of receivables due within a year. So it has liabilities totalling JP¥600.1b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of JP¥826.1b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Mitsui Chemicals's net debt is 2.8 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 55.3 is very high, suggesting that the interest expense on the debt is currently quite low. Sadly, Mitsui Chemicals's EBIT actually dropped 5.3% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Mitsui Chemicals'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. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, Mitsui Chemicals actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

We'd go so far as to say Mitsui Chemicals's conversion of EBIT to free cash flow was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Mitsui Chemicals stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. To that end, you should be aware of the 4 warning signs we've spotted with Mitsui Chemicals .

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.

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