Is Nitto Denko (TSE:6988) Using Too Much Debt?

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 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. We can see that Nitto Denko Corporation (TSE:6988) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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.

See our latest analysis for Nitto Denko

What Is Nitto Denko's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Nitto Denko had debt of JP¥301.0m, up from JP¥284.0m in one year. However, it does have JP¥317.6b in cash offsetting this, leading to net cash of JP¥317.3b.

A Look At Nitto Denko's Liabilities

Zooming in on the latest balance sheet data, we can see that Nitto Denko had liabilities of JP¥188.2b due within 12 months and liabilities of JP¥64.9b due beyond that. On the other hand, it had cash of JP¥317.6b and JP¥210.8b worth of receivables due within a year. So it actually has JP¥275.2b more liquid assets than total liabilities.

This short term liquidity is a sign that Nitto Denko could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Nitto Denko boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Nitto Denko's load is not too heavy, because its EBIT was down 24% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Nitto Denko's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Nitto Denko 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 most recent three years, Nitto Denko recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nitto Denko has net cash of JP¥317.3b, as well as more liquid assets than liabilities. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in JP¥80b. So we are not troubled with Nitto Denko's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Nitto Denko's earnings per share history for free.

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.