Toyo Drilube (TSE:4976) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Toyo Drilube Co., Ltd. (TSE:4976) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Toyo Drilube

How Much Debt Does Toyo Drilube Carry?

You can click the graphic below for the historical numbers, but it shows that Toyo Drilube had JP¥757.0m of debt in September 2024, down from JP¥828.0m, one year before. However, its balance sheet shows it holds JP¥4.67b in cash, so it actually has JP¥3.91b net cash.

A Look At Toyo Drilube's Liabilities

The latest balance sheet data shows that Toyo Drilube had liabilities of JP¥1.60b due within a year, and liabilities of JP¥745.0m falling due after that. Offsetting this, it had JP¥4.67b in cash and JP¥1.36b in receivables that were due within 12 months. So it actually has JP¥3.69b more liquid assets than total liabilities.

This luscious liquidity implies that Toyo Drilube's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Toyo Drilube boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Toyo Drilube has boosted its EBIT by 91%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Toyo Drilube will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Toyo Drilube 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 last three years, Toyo Drilube reported free cash flow worth 10% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Toyo Drilube has net cash of JP¥3.91b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 91% over the last year. So is Toyo Drilube'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 instance, we've identified 1 warning sign for Toyo Drilube that you should be aware of.

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.