Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Aeria Inc. (TYO:3758) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Aeria
What Is Aeria's Debt?
The image below, which you can click on for greater detail, shows that Aeria had debt of JP¥5.46b at the end of December 2020, a reduction from JP¥6.33b over a year. But on the other hand it also has JP¥8.75b in cash, leading to a JP¥3.29b net cash position.
How Strong Is Aeria's Balance Sheet?
According to the last reported balance sheet, Aeria had liabilities of JP¥6.84b due within 12 months, and liabilities of JP¥3.73b due beyond 12 months. Offsetting these obligations, it had cash of JP¥8.75b as well as receivables valued at JP¥2.80b due within 12 months. So it actually has JP¥989.0m more liquid assets than total liabilities.
This surplus suggests that Aeria has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Aeria boasts net cash, so it's fair to say it does not have a heavy debt load!
Shareholders should be aware that Aeria's EBIT was down 83% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is Aeria's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Aeria 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, Aeria actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Aeria has net cash of JP¥3.29b, as well as more liquid assets than liabilities. The cherry on top was that in converted 120% of that EBIT to free cash flow, bringing in -JP¥336m. So we are not troubled with Aeria's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Aeria (of which 1 doesn't sit too well with us!) you should know about.
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. 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.
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About TSE:3758
Mediocre balance sheet and slightly overvalued.
