Is Tohokushinsha Film (TYO:2329) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Tohokushinsha Film Corporation (TYO:2329) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Tohokushinsha Film

How Much Debt Does Tohokushinsha Film Carry?

As you can see below, Tohokushinsha Film had JP¥345.0m of debt at September 2020, down from JP¥860.0m a year prior. But it also has JP¥33.8b in cash to offset that, meaning it has JP¥33.5b net cash.

How Strong Is Tohokushinsha Film's Balance Sheet?

The latest balance sheet data shows that Tohokushinsha Film had liabilities of JP¥13.9b due within a year, and liabilities of JP¥4.25b falling due after that. Offsetting these obligations, it had cash of JP¥33.8b as well as receivables valued at JP¥9.58b due within 12 months. So it can boast JP¥25.2b more liquid assets than total liabilities.

This luscious liquidity implies that Tohokushinsha Film's balance sheet is sturdy like a giant sequoia tree. 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 Tohokushinsha Film has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Tohokushinsha Film's load is not too heavy, because its EBIT was down 35% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tohokushinsha Film will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Tohokushinsha Film 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 last three years, Tohokushinsha Film recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tohokushinsha Film has net cash of JP¥33.5b, as well as more liquid assets than liabilities. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in JP¥3.6b. So we don't think Tohokushinsha Film's use of debt is risky. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Tohokushinsha Film (of which 1 doesn't sit too well with us!) you should know about.

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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