Is SUNNY SIDE UP GROUP (TSE:2180) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 SUNNY SIDE UP GROUP Inc. (TSE:2180) does use debt in its business. But the real question is whether this debt is making the company risky.

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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for SUNNY SIDE UP GROUP

What Is SUNNY SIDE UP GROUP's Debt?

As you can see below, SUNNY SIDE UP GROUP had JP¥956.0m of debt at June 2024, down from JP¥1.18b a year prior. However, its balance sheet shows it holds JP¥3.19b in cash, so it actually has JP¥2.23b net cash.

A Look At SUNNY SIDE UP GROUP's Liabilities

The latest balance sheet data shows that SUNNY SIDE UP GROUP had liabilities of JP¥3.36b due within a year, and liabilities of JP¥975.0m falling due after that. Offsetting these obligations, it had cash of JP¥3.19b as well as receivables valued at JP¥2.58b due within 12 months. So it can boast JP¥1.43b more liquid assets than total liabilities.

This excess liquidity suggests that SUNNY SIDE UP GROUP is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that SUNNY SIDE UP GROUP has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that SUNNY SIDE UP GROUP grew its EBIT by 13% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is SUNNY SIDE UP GROUP's earnings that will influence how the balance sheet holds up in the future. 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 SUNNY SIDE UP GROUP 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. During the last three years, SUNNY SIDE UP GROUP produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that SUNNY SIDE UP GROUP has net cash of JP¥2.23b, as well as more liquid assets than liabilities. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in JP¥525m. So is SUNNY SIDE UP GROUP's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for SUNNY SIDE UP GROUP 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.