Is Tokyo Tekko (TSE:5445) A Risky Investment?

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 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 Tokyo Tekko Co., Ltd. (TSE:5445) makes use of debt. But the real question is whether this debt is making the company risky.

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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Tokyo Tekko

What Is Tokyo Tekko's Net Debt?

As you can see below, at the end of March 2024, Tokyo Tekko had JP¥7.85b of debt, up from JP¥7.34b a year ago. Click the image for more detail. But on the other hand it also has JP¥16.4b in cash, leading to a JP¥8.50b net cash position.

How Healthy Is Tokyo Tekko's Balance Sheet?

The latest balance sheet data shows that Tokyo Tekko had liabilities of JP¥17.0b due within a year, and liabilities of JP¥7.76b falling due after that. Offsetting these obligations, it had cash of JP¥16.4b as well as receivables valued at JP¥9.72b due within 12 months. So it actually has JP¥1.33b more liquid assets than total liabilities.

This surplus suggests that Tokyo Tekko has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tokyo Tekko has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Tokyo Tekko grew its EBIT by 144% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is Tokyo Tekko's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Tokyo Tekko 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 two years, Tokyo Tekko recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Tokyo Tekko has net cash of JP¥8.50b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥7.5b, being 84% of its EBIT. So we don't think Tokyo Tekko's use of debt is risky. 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 example Tokyo Tekko has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.

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