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. We note that Alpha Co., Ltd. (TYO:4760) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
Check out 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 August 2020 Alpha had JP¥1.29b of debt, an increase on JP¥1.05b, over one year. However, it also had JP¥1.10b in cash, and so its net debt is JP¥191.0m.
A Look At Alpha's Liabilities
The latest balance sheet data shows that Alpha had liabilities of JP¥1.92b due within a year, and liabilities of JP¥408.0m falling due after that. On the other hand, it had cash of JP¥1.10b and JP¥986.0m worth of receivables due within a year. So it has liabilities totalling JP¥242.0m more than its cash and near-term receivables, combined.
Alpha has a market capitalization of JP¥965.8m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Alpha 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.
In the last year Alpha had a loss before interest and tax, and actually shrunk its revenue by 13%, to JP¥6.1b. We would much prefer see growth.
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¥474m 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. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through JP¥460m of cash over the last year. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Alpha has 3 warning signs (and 2 which are concerning) we think you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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:4760
Good value with adequate balance sheet.
