Is Nippon Chutetsukan K.K (TSE:5612) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Nippon Chutetsukan K.K. (TSE:5612) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for Nippon Chutetsukan K.K

What Is Nippon Chutetsukan K.K's Net Debt?

As you can see below, at the end of September 2024, Nippon Chutetsukan K.K had JP¥4.95b of debt, up from JP¥3.35b a year ago. Click the image for more detail. However, it also had JP¥2.72b in cash, and so its net debt is JP¥2.23b.

How Strong Is Nippon Chutetsukan K.K's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Nippon Chutetsukan K.K had liabilities of JP¥7.18b due within 12 months and liabilities of JP¥3.14b due beyond that. On the other hand, it had cash of JP¥2.72b and JP¥6.00b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.60b.

While this might seem like a lot, it is not so bad since Nippon Chutetsukan K.K has a market capitalization of JP¥3.79b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

We'd say that Nippon Chutetsukan K.K's moderate net debt to EBITDA ratio ( being 2.1), indicates prudence when it comes to debt. And its strong interest cover of 27.8 times, makes us even more comfortable. We saw Nippon Chutetsukan K.K grow its EBIT by 5.3% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. 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 Nippon Chutetsukan K.K will need earnings to service that debt. 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.

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. During the last three years, Nippon Chutetsukan K.K burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Nippon Chutetsukan K.K's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. When we consider all the factors discussed, it seems to us that Nippon Chutetsukan K.K is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Nippon Chutetsukan K.K that you should be aware of.

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.