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.' 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. 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Nippon Kayaku

What Is Nippon Kayaku's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Nippon Kayaku had debt of JP¥31.5b, up from JP¥19.6b in one year. However, its balance sheet shows it holds JP¥66.2b in cash, so it actually has JP¥34.7b net cash.

How Strong Is Nippon Kayaku's Balance Sheet?

We can see from the most recent balance sheet that Nippon Kayaku had liabilities of JP¥59.8b falling due within a year, and liabilities of JP¥32.8b due beyond that. Offsetting this, it had JP¥66.2b in cash and JP¥62.0b in receivables that were due within 12 months. So it can boast JP¥35.6b more liquid assets than total liabilities.

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

In fact Nippon Kayaku's saving grace is its low debt levels, because its EBIT has tanked 66% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Nippon Kayaku's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. During the last three years, Nippon Kayaku produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nippon Kayaku has net cash of JP¥34.7b, as well as more liquid assets than liabilities. So we don't have any problem with Nippon Kayaku's use of debt. 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. We've identified 4 warning signs with Nippon Kayaku (at least 2 which can't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.