Here's Why Alpha (TYO:4760) Can Afford Some 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.' 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. We note that Alpha Co., Ltd. (TYO:4760) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Alpha

How Much Debt Does Alpha Carry?

You can click the graphic below for the historical numbers, but it shows that as of November 2020 Alpha had JP¥1.49b of debt, an increase on JP¥1.22b, over one year. On the flip side, it has JP¥1.28b in cash leading to net debt of about JP¥215.0m.

A Look At Alpha's Liabilities

Zooming in on the latest balance sheet data, we can see that Alpha had liabilities of JP¥1.96b due within 12 months and liabilities of JP¥765.0m due beyond that. On the other hand, it had cash of JP¥1.28b and JP¥1.24b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥210.0m.

Since publicly traded Alpha shares are worth a total of JP¥1.30b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But it is Alpha'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.

In the last year Alpha had a loss before interest and tax, and actually shrunk its revenue by 12%, to JP¥6.0b. That's not what we would hope to see.

Caveat Emptor

While Alpha's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable JP¥404m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled JP¥460m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. Be aware that Alpha is showing 4 warning signs in our investment analysis , and 1 of those is significant...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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