Here's Why Leopalace21 (TSE:8848) Can Manage Its Debt Responsibly

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.' 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 Leopalace21 Corporation (TSE:8848) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Leopalace21

What Is Leopalace21's Debt?

The chart below, which you can click on for greater detail, shows that Leopalace21 had JP¥30.0b in debt in December 2023; about the same as the year before. But it also has JP¥60.4b in cash to offset that, meaning it has JP¥30.4b net cash.

How Healthy Is Leopalace21's Balance Sheet?

We can see from the most recent balance sheet that Leopalace21 had liabilities of JP¥58.5b falling due within a year, and liabilities of JP¥66.3b due beyond that. On the other hand, it had cash of JP¥60.4b and JP¥4.76b worth of receivables due within a year. So its liabilities total JP¥59.8b more than the combination of its cash and short-term receivables.

Leopalace21 has a market capitalization of JP¥165.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Leopalace21 also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Leopalace21's EBIT launched higher than Elon Musk, gaining a whopping 131% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Leopalace21'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Leopalace21 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 two years, Leopalace21 recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Leopalace21's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥30.4b. And it impressed us with free cash flow of JP¥18b, being 96% of its EBIT. So we don't think Leopalace21'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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Leopalace21 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.