Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that SOMAR Corporation (TSE:8152) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
We've discovered 3 warning signs about SOMAR. View them for free.Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is SOMAR's Debt?
As you can see below, at the end of December 2024, SOMAR had JP¥5.00b of debt, up from JP¥4.00b a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥7.40b in cash, so it actually has JP¥2.40b net cash.
A Look At SOMAR's Liabilities
According to the last reported balance sheet, SOMAR had liabilities of JP¥9.89b due within 12 months, and liabilities of JP¥1.41b due beyond 12 months. Offsetting this, it had JP¥7.40b in cash and JP¥10.0b in receivables that were due within 12 months. So it actually has JP¥6.13b more liquid assets than total liabilities.
This surplus liquidity suggests that SOMAR's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that SOMAR has more cash than debt is arguably a good indication that it can manage its debt safely.
See our latest analysis for SOMAR
In addition to that, we're happy to report that SOMAR has boosted its EBIT by 69%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is SOMAR's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. SOMAR may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, SOMAR reported free cash flow worth 18% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Summing Up
While it is always sensible to investigate a company's debt, in this case SOMAR has JP¥2.40b in net cash and a decent-looking balance sheet. And we liked the look of last year's 69% year-on-year EBIT growth. So we don't think SOMAR's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with SOMAR .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.
About TSE:8152
SOMAR
Engages in materials, resin, environmental material, food, and other business in Japan and internationally.
Flawless balance sheet with proven track record.
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