These 4 Measures Indicate That Ceres (TSE:3696) Is Using Debt Reasonably Well

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. Importantly, Ceres Inc. (TSE:3696) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Ceres

What Is Ceres's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Ceres had JP¥9.68b of debt, an increase on JP¥7.76b, over one year. However, its balance sheet shows it holds JP¥13.4b in cash, so it actually has JP¥3.69b net cash.

A Look At Ceres' Liabilities

We can see from the most recent balance sheet that Ceres had liabilities of JP¥15.2b falling due within a year, and liabilities of JP¥3.59b due beyond that. On the other hand, it had cash of JP¥13.4b and JP¥3.28b worth of receivables due within a year. So it has liabilities totalling JP¥2.10b more than its cash and near-term receivables, combined.

Of course, Ceres has a market capitalization of JP¥36.4b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Ceres also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Ceres has boosted its EBIT by 73%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Ceres'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Ceres may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Ceres created free cash flow amounting to 19% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ceres has JP¥3.69b in net cash. And it impressed us with its EBIT growth of 73% over the last year. So we don't think Ceres's use of debt is risky. 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. We've identified 1 warning sign with Ceres , 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. 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.