Is MicroAd (TSE:9553) 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 note that MicroAd, Inc. (TSE:9553) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 MicroAd

What Is MicroAd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 MicroAd had debt of JP¥2.40b, up from JP¥1.18b in one year. But it also has JP¥2.48b in cash to offset that, meaning it has JP¥74.0m net cash.

How Strong Is MicroAd's Balance Sheet?

The latest balance sheet data shows that MicroAd had liabilities of JP¥4.17b due within a year, and liabilities of JP¥330.0m falling due after that. Offsetting this, it had JP¥2.48b in cash and JP¥1.81b in receivables that were due within 12 months. So its liabilities total JP¥207.0m more than the combination of its cash and short-term receivables.

Of course, MicroAd has a market capitalization of JP¥6.54b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, MicroAd also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that MicroAd's load is not too heavy, because its EBIT was down 63% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MicroAd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. MicroAd 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. Over the last three years, MicroAd reported free cash flow worth 4.5% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that MicroAd has JP¥74.0m in net cash. So although we see some areas for improvement, we're not too worried about MicroAd's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example MicroAd has 4 warning signs (and 1 which is concerning) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.