Cerespo (TYO:9625) Has Debt But No Earnings; Should You Worry?

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 can see that Cerespo Co., Ltd. (TYO:9625) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Cerespo

How Much Debt Does Cerespo Carry?

The image below, which you can click on for greater detail, shows that Cerespo had debt of JP¥1.36b at the end of December 2020, a reduction from JP¥2.57b over a year. But it also has JP¥1.47b in cash to offset that, meaning it has JP¥112.0m net cash.

A Look At Cerespo's Liabilities

Zooming in on the latest balance sheet data, we can see that Cerespo had liabilities of JP¥2.73b due within 12 months and liabilities of JP¥336.0m due beyond that. Offsetting these obligations, it had cash of JP¥1.47b as well as receivables valued at JP¥529.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.06b.

This deficit isn't so bad because Cerespo is worth JP¥4.50b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Cerespo boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Cerespo will need earnings to service that debt. 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.

Over 12 months, Cerespo made a loss at the EBIT level, and saw its revenue drop to JP¥4.6b, which is a fall of 73%. To be frank that doesn't bode well.

So How Risky Is Cerespo?

Although Cerespo had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of JP¥1.3b. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. 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. We've identified 3 warning signs with Cerespo (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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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