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 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. Importantly, Nitto Denko Corporation (TSE:6988) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Nitto Denko

What Is Nitto Denko's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Nitto Denko had JP¥338.0m of debt, an increase on JP¥255.0m, over one year. But it also has JP¥324.2b in cash to offset that, meaning it has JP¥323.9b net cash.

How Healthy Is Nitto Denko's Balance Sheet?

According to the last reported balance sheet, Nitto Denko had liabilities of JP¥222.3b due within 12 months, and liabilities of JP¥59.5b due beyond 12 months. Offsetting these obligations, it had cash of JP¥324.2b as well as receivables valued at JP¥233.3b due within 12 months. So it can boast JP¥275.8b more liquid assets than total liabilities.

This surplus suggests that Nitto Denko is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues 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.

Also positive, Nitto Denko grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nitto Denko has net cash of JP¥323.9b, as well as more liquid assets than liabilities. And we liked the look of last year's 28% year-on-year EBIT growth. So is Nitto Denko's debt a risk? It doesn't seem so to us. 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, we've discovered 1 warning sign for Nitto Denko that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.