Does Kyoei Steel (TSE:5440) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Kyoei Steel Ltd. (TSE:5440) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kyoei Steel

How Much Debt Does Kyoei Steel Carry?

As you can see below, Kyoei Steel had JP¥91.4b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have JP¥43.3b in cash offsetting this, leading to net debt of about JP¥48.1b.

How Strong Is Kyoei Steel's Balance Sheet?

According to the last reported balance sheet, Kyoei Steel had liabilities of JP¥103.3b due within 12 months, and liabilities of JP¥45.0b due beyond 12 months. Offsetting this, it had JP¥43.3b in cash and JP¥90.7b in receivables that were due within 12 months. So it has liabilities totalling JP¥14.3b more than its cash and near-term receivables, combined.

Since publicly traded Kyoei Steel shares are worth a total of JP¥77.8b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Kyoei Steel's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its strong interest cover of 11.0 times, makes us even more comfortable. And we also note warmly that Kyoei Steel grew its EBIT by 16% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Kyoei Steel can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Kyoei Steel reported free cash flow worth 18% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

When it comes to the balance sheet, the standout positive for Kyoei Steel was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. Considering this range of data points, we think Kyoei Steel is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Kyoei Steel you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com