Mitsubishi Chemical Group (TSE:4188) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Mitsubishi Chemical Group Corporation (TSE:4188) does use debt in its business. But is this debt a concern to shareholders?

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Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Mitsubishi Chemical Group's Debt?

The image below, which you can click on for greater detail, shows that Mitsubishi Chemical Group had debt of JP¥2.15t at the end of December 2024, a reduction from JP¥2.29t over a year. On the flip side, it has JP¥337.0b in cash leading to net debt of about JP¥1.81t.

A Look At Mitsubishi Chemical Group's Liabilities

According to the last reported balance sheet, Mitsubishi Chemical Group had liabilities of JP¥1.67t due within 12 months, and liabilities of JP¥2.06t due beyond 12 months. On the other hand, it had cash of JP¥337.0b and JP¥823.7b worth of receivables due within a year. So its liabilities total JP¥2.57t more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the JP¥1.01t 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, Mitsubishi Chemical Group would probably need a major re-capitalization if its creditors were to demand repayment.

Check out our latest analysis for Mitsubishi Chemical Group

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Mitsubishi Chemical Group has net debt to EBITDA of 3.6 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 8.1 times its interest expense, and its net debt to EBITDA, was quite high, at 3.6. Importantly, Mitsubishi Chemical Group's EBIT fell a jaw-dropping 52% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Mitsubishi Chemical Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Mitsubishi Chemical Group recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Mitsubishi Chemical Group's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Mitsubishi Chemical Group to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Mitsubishi Chemical Group that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.