Adeka (TSE:4401) Seems To Use Debt Quite Sensibly

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 note that Adeka Corporation (TSE:4401) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Adeka

What Is Adeka's Net Debt?

As you can see below, at the end of September 2024, Adeka had JP¥59.0b of debt, up from JP¥44.7b a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥109.4b in cash, so it actually has JP¥50.3b net cash.

How Strong Is Adeka's Balance Sheet?

The latest balance sheet data shows that Adeka had liabilities of JP¥114.4b due within a year, and liabilities of JP¥69.6b falling due after that. Offsetting these obligations, it had cash of JP¥109.4b as well as receivables valued at JP¥91.4b due within 12 months. So it can boast JP¥16.8b more liquid assets than total liabilities.

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

Also positive, Adeka grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. 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 Adeka'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. Adeka 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. Looking at the most recent three years, Adeka recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Adeka has net cash of JP¥50.3b, as well as more liquid assets than liabilities. And we liked the look of last year's 21% year-on-year EBIT growth. So is Adeka's debt a risk? It doesn't seem so to us. Given Adeka has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.