Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Sumitomo Osaka Cement Co., Ltd. (TSE:5232) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Sumitomo Osaka Cement
How Much Debt Does Sumitomo Osaka Cement Carry?
The image below, which you can click on for greater detail, shows that Sumitomo Osaka Cement had debt of JP¥89.2b at the end of June 2024, a reduction from JP¥95.9b over a year. On the flip side, it has JP¥16.7b in cash leading to net debt of about JP¥72.4b.
A Look At Sumitomo Osaka Cement's Liabilities
We can see from the most recent balance sheet that Sumitomo Osaka Cement had liabilities of JP¥94.2b falling due within a year, and liabilities of JP¥71.2b due beyond that. On the other hand, it had cash of JP¥16.7b and JP¥52.9b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥95.8b.
This deficit is considerable relative to its market capitalization of JP¥112.6b, so it does suggest shareholders should keep an eye on Sumitomo Osaka Cement's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Sumitomo Osaka Cement's net debt to EBITDA ratio of about 2.4 suggests only moderate use of debt. And its strong interest cover of 1k times, makes us even more comfortable. Notably, Sumitomo Osaka Cement made a loss at the EBIT level, last year, but improved that to positive EBIT of JP¥8.4b in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sumitomo Osaka Cement 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Sumitomo Osaka Cement actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
Sumitomo Osaka Cement's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. Considering this range of data points, we think Sumitomo Osaka Cement is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. We've identified 2 warning signs with Sumitomo Osaka Cement , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
About TSE:5232
Sumitomo Osaka Cement
Engages in the cement production business in Japan and internationally.
Undervalued with excellent balance sheet and pays a dividend.