Is Sumitomo Bakelite (TSE:4203) A Risky Investment?

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.' 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. Importantly, Sumitomo Bakelite Company Limited (TSE:4203) does carry debt. But the more important question is: how much risk is that debt creating?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sumitomo Bakelite

How Much Debt Does Sumitomo Bakelite Carry?

The image below, which you can click on for greater detail, shows that at December 2023 Sumitomo Bakelite had debt of JP¥47.8b, up from JP¥43.6b in one year. But on the other hand it also has JP¥109.6b in cash, leading to a JP¥61.8b net cash position.

How Strong Is Sumitomo Bakelite's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sumitomo Bakelite had liabilities of JP¥89.6b due within 12 months and liabilities of JP¥37.0b due beyond that. On the other hand, it had cash of JP¥109.6b and JP¥65.3b worth of receivables due within a year. So it can boast JP¥48.3b more liquid assets than total liabilities.

This short term liquidity is a sign that Sumitomo Bakelite could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Sumitomo Bakelite boasts net cash, so it's fair to say it does not have a heavy debt load!

Sumitomo Bakelite's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 Sumitomo Bakelite'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. Sumitomo Bakelite 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. Over the most recent three years, Sumitomo Bakelite recorded free cash flow worth 65% 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 it is always sensible to investigate a company's debt, in this case Sumitomo Bakelite has JP¥61.8b in net cash and a decent-looking balance sheet. So is Sumitomo Bakelite's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Sumitomo Bakelite .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.