We Think Karadanote (TSE:4014) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Karadanote, Inc. (TSE:4014) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Karadanote

What Is Karadanote's Net Debt?

The image below, which you can click on for greater detail, shows that Karadanote had debt of JP¥350.0m at the end of January 2024, a reduction from JP¥450.0m over a year. But it also has JP¥473.0m in cash to offset that, meaning it has JP¥123.0m net cash.

How Healthy Is Karadanote's Balance Sheet?

According to the last reported balance sheet, Karadanote had liabilities of JP¥404.0m due within 12 months, and liabilities of JP¥255.0m due beyond 12 months. On the other hand, it had cash of JP¥473.0m and JP¥451.0m worth of receivables due within a year. So it actually has JP¥265.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Karadanote could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Karadanote has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Karadanote turned things around in the last 12 months, delivering and EBIT of JP¥15m. There's no doubt that we learn most about debt from the balance sheet. But it is Karadanote'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Karadanote 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. Over the last year, Karadanote saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Karadanote has JP¥123.0m in net cash and a decent-looking balance sheet. So we are not troubled with Karadanote's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Karadanote (of which 2 shouldn't be ignored!) you should know about.

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.