These 4 Measures Indicate That Nitto Denko (TSE:6988) Is Using Debt Safely

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Nitto Denko Corporation (TSE:6988) makes use of debt. But is this debt a concern to shareholders?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Nitto Denko

What Is Nitto Denko's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Nitto Denko had JP¥396.0m of debt, an increase on JP¥263.0m, over one year. But on the other hand it also has JP¥340.3b in cash, leading to a JP¥339.9b net cash position.

A Look At Nitto Denko's Liabilities

According to the last reported balance sheet, Nitto Denko had liabilities of JP¥224.4b due within 12 months, and liabilities of JP¥59.0b due beyond 12 months. Offsetting these obligations, it had cash of JP¥340.3b as well as receivables valued at JP¥222.9b due within 12 months. So it can boast JP¥279.7b more liquid assets than total liabilities.

It's good to see that Nitto Denko has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Nitto Denko has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Nitto Denko grew its EBIT by 55% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

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 it is always sensible to investigate a company's debt, in this case Nitto Denko has JP¥339.9b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 55% over the last year. So is Nitto Denko's debt a risk? It doesn't seem so to us. 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.

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.