Is Yamato Kogyo (TSE:5444) Using Too Much 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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Yamato Kogyo Co., Ltd. (TSE:5444) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Yamato Kogyo

What Is Yamato Kogyo's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Yamato Kogyo had debt of JP¥2.55b, up from none in one year. However, it does have JP¥252.7b in cash offsetting this, leading to net cash of JP¥250.1b.

How Strong Is Yamato Kogyo's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yamato Kogyo had liabilities of JP¥33.4b due within 12 months and liabilities of JP¥31.9b due beyond that. On the other hand, it had cash of JP¥252.7b and JP¥23.2b worth of receivables due within a year. So it actually has JP¥210.6b more liquid assets than total liabilities.

This luscious liquidity implies that Yamato Kogyo's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Yamato Kogyo has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Yamato Kogyo saw its EBIT decline by 5.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Yamato Kogyo's ability to maintain a healthy balance sheet going forward. 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. While Yamato Kogyo 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. Over the last three years, Yamato Kogyo actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Yamato Kogyo has net cash of JP¥250.1b, as well as more liquid assets than liabilities. The cherry on top was that in converted 371% of that EBIT to free cash flow, bringing in JP¥68b. So we don't think Yamato Kogyo's use of debt is risky. 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. For example, we've discovered 1 warning sign for Yamato Kogyo that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.