These 4 Measures Indicate That Sumitomo Bakelite (TSE:4203) Is Using Debt Safely

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 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 Sumitomo Bakelite Company Limited (TSE:4203) does use debt in its business. But is this debt a concern to shareholders?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sumitomo Bakelite

How Much Debt Does Sumitomo Bakelite Carry?

As you can see below, Sumitomo Bakelite had JP¥36.8b of debt at December 2024, down from JP¥47.8b a year prior. But it also has JP¥124.3b in cash to offset that, meaning it has JP¥87.5b net cash.

A Look At Sumitomo Bakelite's Liabilities

According to the last reported balance sheet, Sumitomo Bakelite had liabilities of JP¥87.1b due within 12 months, and liabilities of JP¥44.0b due beyond 12 months. Offsetting these obligations, it had cash of JP¥124.3b as well as receivables valued at JP¥64.4b due within 12 months. So it actually has JP¥57.7b more liquid assets than total liabilities.

This excess liquidity suggests that Sumitomo Bakelite is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Sumitomo Bakelite boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Sumitomo Bakelite saw its EBIT decline by 3.0% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sumitomo Bakelite can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sumitomo Bakelite 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, Sumitomo Bakelite recorded free cash flow worth 71% 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¥87.5b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in JP¥27b. So we don't think Sumitomo Bakelite's use of debt is risky. 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. For instance, we've identified 1 warning sign for Sumitomo Bakelite that 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.