Is Kasumigaseki CapitalLtd (TSE:3498) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Kasumigaseki Capital Co.,Ltd. (TSE:3498) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Kasumigaseki CapitalLtd

What Is Kasumigaseki CapitalLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of November 2024 Kasumigaseki CapitalLtd had JP¥72.0b of debt, an increase on JP¥30.4b, over one year. However, it does have JP¥33.2b in cash offsetting this, leading to net debt of about JP¥38.8b.

How Healthy Is Kasumigaseki CapitalLtd's Balance Sheet?

The latest balance sheet data shows that Kasumigaseki CapitalLtd had liabilities of JP¥34.5b due within a year, and liabilities of JP¥46.0b falling due after that. Offsetting this, it had JP¥33.2b in cash and JP¥1.37b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥46.0b.

While this might seem like a lot, it is not so bad since Kasumigaseki CapitalLtd has a market capitalization of JP¥133.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Kasumigaseki CapitalLtd has a debt to EBITDA ratio of 3.4, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 13.9 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Pleasingly, Kasumigaseki CapitalLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 128% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kasumigaseki CapitalLtd'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Kasumigaseki CapitalLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Kasumigaseki CapitalLtd is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Kasumigaseki CapitalLtd's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Kasumigaseki CapitalLtd is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.