Nippon Kayaku (TSE:4272) Has A Pretty Healthy Balance Sheet

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.' 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 Nippon Kayaku Co., Ltd. (TSE:4272) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Nippon Kayaku

How Much Debt Does Nippon Kayaku Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Nippon Kayaku had JP¥28.7b of debt, an increase on JP¥26.2b, over one year. However, it does have JP¥53.8b in cash offsetting this, leading to net cash of JP¥25.1b.

How Healthy Is Nippon Kayaku's Balance Sheet?

The latest balance sheet data shows that Nippon Kayaku had liabilities of JP¥62.7b due within a year, and liabilities of JP¥29.8b falling due after that. On the other hand, it had cash of JP¥53.8b and JP¥61.1b worth of receivables due within a year. So it can boast JP¥22.4b more liquid assets than total liabilities.

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

Fortunately, Nippon Kayaku grew its EBIT by 8.0% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Nippon Kayaku can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. While Nippon Kayaku 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. In the last three years, Nippon Kayaku's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nippon Kayaku has net cash of JP¥25.1b, as well as more liquid assets than liabilities. And it also grew its EBIT by 8.0% over the last year. So is Nippon Kayaku'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. For example Nippon Kayaku has 3 warning signs (and 1 which is significant) we think you should know about.

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.