Is GMO TECH (TSE:6026) A Risky Investment?

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.' 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 GMO TECH, Inc. (TSE:6026) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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 GMO TECH

What Is GMO TECH's Debt?

You can click the graphic below for the historical numbers, but it shows that GMO TECH had JP¥262.0m of debt in March 2024, down from JP¥332.0m, one year before. However, it does have JP¥898.0m in cash offsetting this, leading to net cash of JP¥636.0m.

A Look At GMO TECH's Liabilities

According to the last reported balance sheet, GMO TECH had liabilities of JP¥1.45b due within 12 months, and liabilities of JP¥205.0m due beyond 12 months. Offsetting these obligations, it had cash of JP¥898.0m as well as receivables valued at JP¥1.11b due within 12 months. So it actually has JP¥357.0m more liquid assets than total liabilities.

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

Even more impressive was the fact that GMO TECH grew its EBIT by 171% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is GMO TECH'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. GMO TECH 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. Looking at the most recent two years, GMO TECH recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case GMO TECH has JP¥636.0m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 171% over the last year. So we don't think GMO TECH's use of debt is risky. 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. For instance, we've identified 3 warning signs for GMO TECH (1 is potentially serious) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com